Latent issues continue to plagues the market
Since the emergence of latent claim categories such as asbestos and pollution in the mid-1980s, legacy issues have proved to be a major problem for the insurance sector. Insurers are still finding that the reserves set aside to pay for future claims are often inadequate as further sources of claims surface, affecting business already assumed and typically arising out of long-tail casualty lines. Problems stem from new claim categories unknown at the time that policies were written, particularly for business written on an occurrence basis.Whilst there are exceptions, insurers do not generally hold reserves for the emergence of unknown or unanticipated claim categories. Of course, accurate quantification of claim types that are yet to emerge is impossible.Instead, the industry is forced into taking large one-off (or more regular) hits to its balance sheets as issues emerge and the reserves increase.Indeed, over the last twelve months, the insurance world has been inundated with myriad examples. Munich Re, ACE, XL, AIG and The Hartford are some of the prominent re/insurers which have strengthened prior years' reserves.The repercussions are significant in terms of financial position, rating downgrades and share price movements.
Asbestos on the agendaAsbestos remains very much a major issue, particularly in the US. Quantification of European (including UK) asbestos exposure is also uncertain, although at this stage it appears unlikely that these exposures will have a comparable impact to the US ones. Australia, as a large asbestos mining country, is also seeing the impact of increased mesothelioma claims. On the other hand, pollution is not expected to cause major surprises.However, an important point is that legacy problems are not always due to the well-known asbestos or pollution issues. Over the years these have been well-researched and documented, but legacy issues can have many faces.For prospective business, insurers can attempt to factor emerging issues into premiums or policy terms. For example, many liability classes are now written on a claims made basis, reducing the effects of reporting delays, as seen with latent claims. However, for business that continues to be or has already been written on an occurrence basis such as workers' compensation in the US, employer's liability and public liability business in the UK, legacy issues remain a source of concern. The resurgence of recognised health hazards such as industrial deafness, vibration white finger, occupational asthma, dermatitis and allergies to latex and other substances, remains a threat to such classes of business. However, a great risk also comes from new types of claims.Regularly in the news we hear stories and warnings about the potentially harmful effects of everyday products and consumables. These may range from passive smoking (which has already resulted in out of court settlements in the UK and jury awards in Australia), to mad cow disease (Bovine Spongiform Encephalopathy), to concerns over the safety of farmed salmon or genetically modified food.
IT anxietiesAt the same time, scientific progress and the rapid advancement of technology can be a source of additional concern. If we take the chemicals industry as an example, around 500 new chemicals are introduced each year, and many companies are not aware of their statutory obligation regarding the control of hazardous substances. Consequently, both employees and the public face the risk of low-level, long-term exposure to such substances.The European Commission believes some of these substances might be at least partly responsible for the rise in allergies and ill health in recent years.
Mobile misgivingsConcern also continues over mobile phones and the electromagnetic fields generated by power cables and pylons, even though medical studies so far have not demonstrated any adverse health impact. The latest developments earmarked for special attention are nanotechnology and pervasive computing.On the other hand, other types of claims are also emerging such as lawsuits against fast food manufacturers in the US by clinically obese people on the grounds that fast food products are making them fat. Absurd though these may seem, such claims are the manifestation of an increasingly litigious society. The US is still ahead, but the compensation culture is also changing in the UK and in other parts of Europe, as people become more aware of their rights and are more willing to take legal action. Recent research by the Institute of Actuaries suggested that the developing compensation culture was costing the UK about 1% of GDP. The research estimated that this cost is growing at approximately 15% per year, well ahead of economic growth. A large proportion of this cost will be borne by the insurance sector.Where the victim feels stigmatised, for example if they have suffered due to sexual abuse or following wrongful imprisonment or conviction, these changing attitudes could have significant effects. Recently in the UK, there has been a slew of cases of wrongfully imprisoned mothers, convicted solely on the evidence of 'expert witnesses' as killers of their children, and of families who may have had their children wrongfully taken away from them. These are examples of cases that may result in claims against local authorities and other involved parties. Indeed, on the very sensitive subject of abuse, particularly involving the most vulnerable members of society such as children, the disabled and the elderly, substantial damages may be awarded. Similarly, there may also be an increase in discrimination claims (by sex, race or age) as the propensity to claim increases.Though by definition latent claims will affect occurrence business, reserve deterioration is not always confined to business written on an occurrence basis. Take US casualty business, where a substantial part is written on a claims made basis. The late 1990s and early 2000s have left a particularly bitter taste for many companies writing direct or reinsurance business, as they have been forced to revise original reserve estimates upwards as the true picture of this business has come to light.The period was characterised by significant underpricing and extensions of coverage while multi-year policies and binders and lineslips were common.Combined in some cases with weak underwriting control, monitoring and data capture, this led to uncertainty and delays in quantifying the true exposures and resulting claims over this period. Indeed, the extended exposure periods led to a further delay in the underlying development of the casualty losses. Unfortunately these factors were also combined with an increasingly adverse claims environment both in terms of frequency and severity, a number of high profile losses in new areas such as IPO laddering, and major corporate failures such as WorldCom and Enron. The overall effect was an uncertain reserving environment and a delay in the recognition of how unprofitable some of this business had been. Combined with the effects of losses generated by the 9/11 events, the results for the industry have been disastrous.Unfortunately it is possible that not all of the bad news is out yet.In a recent report, Moody's estimated that the property/casualty industry may still be under-reserved by as much as $30bn, from non-asbestos/pollution exposures alone.In any case, casualty claims have a long lifespan from occurrence to settlement. While open, they may be subject to legislative changes or rulings that may apply retrospectively, as happened with the Ogden changes in the UK for personal injury claims. More recently in the UK, the House of Lords, Fairchild ruling negates the claimant providing definitive evidence of causation and this may impact not just asbestos cases but potentially other latent-type losses.In addition, many companies may not even be fully aware of the extent of their legacy or other exposures due to inadequate systems, data capturing and controls used at the time the business was originally underwritten.This may be the case not just for older years but for current business as well. In the London market, delegated authorities such as binding agreements are a prime example. In many cases, the underwriters were advised on a block basis with little detail of the underlying risks included. This lack of detail was aggravated by the inclusion of multi-year declarations which extended the period of exposure for the re/insurer beyond the expiry date of the binding agreement. The general lack of information has led to losses being incurred for risks not even remotely contemplated at the time the business was written.Mergers and takeovers have also led to data being left incomplete or in older systems which are incompatible with the new parent company's technology. As a result, data may not be maintained as rigorously and may be hard to access.
Legacy of long-tailAnother worrying aspect linked with the delayed emergence of long-tail claims is that the reinsurers of the original insurers are being ceded a large slice of higher claims and their resources are also put under pressure. This has led to greater scrutiny and control of claims payments to cedants, and added to cedants' concerns on 'willingness to pay' in addition to ability to pay. It is becoming more common for reinsurers to request audits of their cedants to see if the reinsurer can mitigate and/or delay payment. In some instances the reinsurer may even be preparing the ground to set a 'negotiated' (code for reduced) claim payment. Thus with current and future legacy issues the cedant cannot automatically assume that when payment is required their reinsurers will be able and/or willing to pay.Legacy issues arise out of the unknown and the unanticipated (rightly or wrongly). Going forward, insurers can take measures to mitigate and manage risk and uncertainty in respect of new business written. The past is more difficult to deal with and retrospective reinsurance has been the most common way that companies can protect themselves against deterioration in legacy accounts. There are, however, no 'free lunches' and cedants have been forced to recognise the potential downside of their legacy portfolios and pay appropriate premiums, particularly in a hardening market.The increased use of solvent schemes of arrangement has also provided a number of cedants with an alternative exit route. The development of specialist run-off operations that offer focused and cost-effective management of legacy portfolios has enabled cedants to offload the resource and management issues, but not the cost.Nick Buckley, Phaedra Kouseli and Bob Phillips are all members of the ReMetrics team at reinsurance intermediary Benfield.