A Californian court decision could have huge ramifications for the re/insurance sector. By Mark McCausland.
On 5 May 2003, a jury in a Los Angeles Superior Court reached a decision that has massive implications for the insurance and reinsurance industry throughout the world. The Californian jury decided that the Fuller-Austin Settlement Trust was entitled to recover immediately the total projected liabilities in relation to asbestos claims from Fuller-Austin's insurers, up to the full policy limits. This judgment required immediate payment of nearly $200m.
Implications for insurers
If this decision is upheld on appeal, the potential implications for the insurance industry are very serious. Insurers, instead of being able to meet claims as they become payable over a period of, say, the next 40 years, will be required to fund these claims in full and with immediate effect.
Clearly this has enormous implications for insurers' cashflows. Some insurance companies reserve for asbestos claims on a basis that takes into consideration future investment growth. This enables them to hold significantly lower sums than would eventually be required, as they expect the investment income earned on these reserves to make good any shortfall. If insurers are forced to fund future claims today, they will be hit with a double blow. First, they will probably need to realise a proportion of their investment portfolio, thus losing future investment income, while simultaneously suffering potential capital losses due to the market's low level. Second, they are likely to be exposed to early redemption penalties if they are forced to realise certain fixed-term assets before the maturity date - for example bonds.
Equally significant is the fact that some large rating agencies believe that the total asbestos-related reserves currently held by US primary insurers are not sufficient to meet their obligations. While the market has recently seen some strengthening in this area, the extent of this under reserving is estimated to be as high as $25bn. Many of these companies were planning to accept a slow bleed on future earnings to fund any shortfall in reserves. If the Fuller-Austin verdict is upheld on appeal, they will no longer have this option, and will face a sudden and significant strain on insurance company reserves.
Even in today's hard market, insurers are still feeling vulnerable. Many are struggling with solvency margins as a consequence of the global stock market decline and some are still recovering from the terrible events of September 11.
Provision of rights
This court decision is particularly contentious, as it effectively provides the bankrupt insured with greater rights to their insurance asset than those who are still solvent. By allowing bankrupt insureds to be able to claim not only for past claims, but also for future claims, the Superior Court is changing the basis upon which claims under these policies can be settled.
The change in basis is demonstrated by one of the decisions arising from the Fuller-Austin case. The judge said: "An insurance company's obligation to its policyholder does not end if the policyholder is bankrupt or insolvent ... In fact, a policyholder's bankruptcy transforms indemnity policies into liability policies ... and excuses a policyholder from conditions it cannot meet as a result of the bankruptcy."
The rising number of asbestos-related claims is causing a corresponding increase in the numbers of companies going into Chapter 11 bankruptcy. The funding problem for insurers is exacerbated when one considers the effect on their ability to collect on their reinsurance. Non-proportional reinsurers are not bound by the Fuller-Austin ruling and will be entitled to maintain their right to meet claims only as they become payable, and only after proof of causation, exposure and identification of the re/insured product. For many of the reasons stated before, reinsurers are unlikely to be willing to relinquish these rights. Rather, they are likely to defend them vigorously.
As a result, many primary insurers would be left both exposed and isolated. On the one hand, they would be forced to fund all future claims immediately, and on the other they would be deprived of the one asset that would counter the strain on their liquidity and possibly their survival. Unless otherwise prevented, they could be tempted to use reserves earmarked for other sources of liabilities to fund this shortfall. This could result in under-reserving within their property/casualty books of business. With the liabilities associated with these types of risks there is a much shorter period between incident and presentation of a claim, and so insurers that take this step risk deferring the inevitable financial difficulties.
The question many insurers and reinsurers are asking themselves is, how many more claimants are left out there? The problem is that the vast majority of new asbestos claimants (75% to 90%) are currently unimpaired, or are suffering from non-malignant diseases. The sheer volume of such claims is breathtaking and the increasing number of companies entering into Chapter 11 bankruptcy reflects the power of these unimpaired claimants. Almost 60% of the total number of asbestos-related bankruptcies have occurred in the last five years.
Clearly, insurance does not have infinite reserves; one day the money will run out. Then what recourse will be available to the genuinely impaired mesothelioma or asbestosis sufferer? To whom will they take their claim?
It is likely that the economic, as well as the human, cost of the asbestos tragedy was the catalyst for Congress to start the long process towards legislating for such an eventuality. Orrin Hatch, a Republican senator, has sponsored a bill that would create an asbestos trust fund (see Global Reinsurance, June 2003). This trust fund would be financed partly by the insurance industry and partly by the insurance defendants themselves. The claims from this fund would be screened and administered under a new special federal asbestos court, as created by the bill.
Senator Hatch is expected to ask insurers and defendants to pay $67.5bn each into the trust. This is an increase from the original request of $45bn each. A further $18bn is expected to be provided by other sources, including existing asbestos trusts formed by bankrupt companies.
The crucial difference between Senator Hatch's approach and the Fuller-Austin verdict is that under the former the payment of these sums would be staggered over time. This would remove some of the enormous problems that would result if the Fuller-Austin decision is upheld.
However, Senator Hatch's bill does not enjoy unanimous support.
The Association of Trial Lawyers of America (ATLA) and others have argued that the bill, in its current form, will not generate enough money to pay all potential victims (and expenses) and that the level of payouts will, as a result, be reduced. However, the recent proposed increase from $108bn to $153bn has gone some way to reducing opposition towards the bill.
A contentious issue facing the bill is whether the federal government would guarantee payment if the trust ever ran out of money. A federal guarantee has little support in Congress, and Senator Hatch's bill currently does not ask for one. Certainly the insurance industry would welcome such an addition, as without the guarantee of finality, little will have changed for the insurance and reinsurance industry.
While in principle some of the obstacles have already been overcome, for example the medical criteria and exclusion of the 'worried well', the time available for any asbestos trust fund bill is extremely limited. Senator Hatch has until August to get his bill passed into law, otherwise it is likely to be lost in the political frenzy of the presidential election.
In conclusion, in the absence of asbestos reform that takes into account the needs of both the victim and the economy, we could see the day when it is not just bankrupt companies that are paying 5 cents in the dollar, but insurance companies too.
One thing is certain - the tail associated with asbestos litigation is likely to be as long as that associated with asbestos liabilities.
By Mark McCausland
Mark McCausland is a partner at London-based actuary and consultant Lane Clark & Peacock LLP. The views expressed in the article are those of the author and are not necessarily those of LCP as a firm.