Thoughts on Hartford’s Annual Asbestos Reserve Evaluations
8/17/2016 By Jonathan Terrell
The Hartford Insurance Company (“Hartford”) recently released its second quarter earnings report. The press release and 10Q provide some interesting reading, as the financial results of their annual “ground-up” asbestos reserve evaluations are included.
Here are some highlights and commentary:
Hartford increased asbestos reserves (net of reinsurance) by $197 million. This represents a 12 percent increase in reserves at the beginning of the year ($1,712 million).
The ground-up asbestos review comprised a review of all its open direct insurance accounts exposed to asbestos liability, as well as assumed reinsurance accounts (reinsurance that Hartford wrote, assuming the risks of other insurance companies).
Hartford reported that “A substantial majority of the Company’s direct accounts have trended as expected”. Also, that “The Company has observed no material changes in the underlying legal environment”.
The increase in reserves was driven by mesothelioma claims which “have not declined as expected for a small subset of peripheral defendants with a high concentration of asbestos filings in specific, adverse jurisdictions. As a result, aggregate indemnity and defense costs have not declined as expected.”
KCIC data shows that Madison County by far remains the epicenter for mesothelioma filings, with more than 10 times the filings of the next highest jurisdiction. (Watch for KCIC’s soon-to-be-released 2016 First Half Asbestos Report).
Hartford divides its asbestos exposures into Direct (from policies issued to corporate policyholders), Assumed Reinsurance, and London Market. Given that Hartford discloses its ground-up study was for domestic direct and assumed reinsurance accounts, the implication is that it did not include London Market exposures.
The Company further discloses that it classifies its asbestos exposures into Major Asbestos Defendants, Non-Major Accounts, and Unallocated Direct Accounts.
Major Asbestos Defendants represent the “top 70” accounts in Tillinghast’s published Tiers 1 and 2 and Wellington accounts. Only someone deeply versed in the history of asbestos litigations would have any idea what that means! Tillinghast is a predecessor of Towers Perrin, the actuarial consulting firm. It classifies Tier 1 asbestos defendants as “The group of primary asbestos defendants who are expected to exhaust nearly all available insurance coverage.” They classify Tier 2 defendants as “The group of asbestos defendants who have been involved in asbestos litigation almost since inception, but whose share is smaller than Tier 1.
Hartford defines Non-Major Accounts as “all other open direct asbestos accounts and largely represents smaller and more peripheral defendants.”
Unallocated Direct Accounts is made up of two pieces:
1. An estimate of the necessary reserves needed for policyholders that have yet to submit an asbestos claim.
2. An estimate of reserves needed for asbestos claims not subject to the product aggregate in the insurance policy. (These are also known as non-products liabilities – and are particularly dangerous for insurance companies, as this liability may be unlimited.)
Hartford discloses that Major Asbestos Defendants account for just 3 percent of gross reserves (before reinsurance offset) at June 30, 2016. At first sight, this is quite surprising. The companies that are the long established major defendants in asbestos litigation are an immaterial part of the Company’s loss reserves. These Major Asbestos Defendants, to the extent they are still solvent, are as significant an element of the tort system as ever. What this statistic is saying is that, for the most part, they have run out of insurance and no longer represent a significant liability for Hartford.
This is consistent with KCIC’s own experience — that many of the defendants with the highest claims counts have exhausted their insurance. They are free to defend the cases as they see fit, without their defense strategy controlled or influenced by their insurers.
I have written extensively elsewhere about the extreme concentration of asbestos-related insurance risk at Berkshire Hathaway through a financial instrument known as “retroactive reinsurance”. Claims handling is concentrated at Resolute Management, the Berkshire Hathaway run-off administration subsidiary, which has a very particular and strong view about the “right” way to administer asbestos claims.
It seems that there are two concentrations of influence emerging in the asbestos defense world: on the one hand, the “Major Defendants” without remaining insurance and on the other hand, Berkshire Hathaway.
Hartford goes on to disclose that Non-Major Accounts represent approximately 58 percent of gross reserves and comprise 1,088 individual accounts (or policyholders). This is a fascinating statistic as well. The majority of Hartford’s liabilities are not from major defendants at all, but from a large number of smaller, more peripheral defendants. This is also squarely consistent with KCIC’s observations based on processing the majority of the asbestos complaints filed in the U.S. In 2015, we noted over 9,000 individual companies identified on over 5,000 complaints processed. The average number of companies named per complaint was 66. The plaintiffs’ bar continues to cast the net very wide, ensnaring companies with only the most passing nexus to asbestos, and the asymmetry of litigation risk puts enormous pressure on these new defendant companies to settle.
We can deduce that 39 percent of asbestos reserves are for unallocated Direct Accounts — policyholders that have yet to file a claim. In technical insurance parlance, this is referred to as Incurred But Not Reported (IBNR). This is not a surprising statistic. But it is interesting to note that a very significant amount of reserves are set aside for policyholders that have yet to report a claim. For this exceptionally long-running tort, the end is nowhere in sight.
Hartford’s $197 million increase in net asbestos reserves (12 percent), follows an increase of $146 million in the second quarter of 2015, also following a ground-up asbestos study. Reserve setting is as much art as science. Actuaries make educated guesses about future claim severity, and there is really nothing fishy about Hartford’s actions. On the contrary, they are taking a responsible action in the light of developing events. But something is surprising, and I am not picking on Hartford — this is an insurance industry-wide phenomenon. What is surprising is that 30 years after the emergence of asbestos-related personal injury claims as a major class of tort, the industry has still been unable to get its head around the magnitude of the problem and set fully realistic reserves. For example, over the last 15 years, Hartford has added $4,760 million to its net reserves. In other words, its reserves of $572 at December 31, 2001, were only 11 percent of what subsequent reserve development indicated they should have been. A similar pattern can be observed in the reserve development for the industry as a whole.
This kind of uncertainty makes me very suspicious of industry reorganizations, such as theOneBeacon-Trebuchet transaction in 2014, or the Royal-Arrowpoint one in 2006. In those transactions, actuarial opinions and testimony were front and center in the approval process and provided the cover for regulators to approve transactions deeply prejudicial to the interests of policyholders. Inevitably policyholders are left holding the bill. Experience shows that so-called “actuarial science” can only be relied on to get the estimation of asbestos reserves very wrong!
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In addition to leading KCIC's business operations, Mr. Terrell is in demand as an expert witness in disputes involving insurance company reorganizations, economic damage calculations, and insurance coverage valuation. He also writes extensively on KCIC’s “Risky Business” blog about industry-related topics, as well as on Entrepreneurship and Organizational Health.