Issues & Trends with Asbestos(and other toxic/mass torts)

Casualty Loss Reserve SeminarSeptember 11, 2001

New Orleans, LA

Douglas W. Oliver, ACAS, MAAA, ARMVice President & DirectorCorporate Solutions Division

Fear

Hope

Fear

Fear

Asbestos is still an issue for:

• Carriers who provided General Liability coverage

• Manufacturers who included asbestos in their products

• Firms utilizing asbestos embedded material in their operations, now or at sometime in the past

• The experts who opine on the magnitude of the issue (problem?)

Asbestos is still an issue for Carriers:

• Equitas:

“During the past year, Equitas strengthened undiscounted asbestos reserves, gross of reinsurance, by £1.7 billion ($2.4 billion), a 27 percent boost to £8 billion ($11.4 billion), according to the group’s financial results for the year ended March 31, 2001.”

National Underwriter, July 23, 2001

Asbestos is still an issue for Carriers:

• Equitas• CNA:

“The company recorded a $1.7 billion after-tax charge associated with a change in estimate of prior year net loss and allocated loss adjustment expense reserves (“loss reserves”), including $0.8 billion after-tax related to asbestos, environmental pollution and mass tort claims.”

CNA Financial Corp.’s 2nd Quarter 2001 Results Press Release, 8/2/01

Asbestos is still an issue for Carriers:

• Equitas • CNA• American Financial:

“While management presently does not have sufficient information to accurately quantify the level or range of any additional exposure, the additional costs of adjudicating or settling pending and future claims may materially exceed amounts currently established and may be material to the period in which they are recorded.”

American Financial Group’s June 30, 2001 10-Q

Asbestos is still an issue for Carriers:

• Equitas• CNA• American Financial• Allstate:

“Management believes its net loss reserve for environmental, asbestos and other mass tort claims are appropriately established based on available facts, technology, laws and regulations.”

“Due to the uncertainties and factors described above, management believes it is not practicable to develop a meaningful range for any such additional net loss reserve that may be required.”

Allstate Corp.’s June 30, 2001 10-Q

Is it still an issue for Manufacturers?

Eight Major Asbestos Bankruptcies in the past year representing firms with combined revenue of > $17 Billion including: Owens Corning Armstrong World Industries W.R. Grace U.S. Gypsum

Remaining Manufacturers are struggling:

What do the following have in common?

What do the following have in common?

Chiquita

IBM

Kohler

Pfizer

Georgia-Pacific

What about the non-obvious?

One law-firm website lists over 250 companies that “may have manufactured and distributed asbestos or asbestos-related products” including:

• Chiquita• Georgia Pacific• IBM• Kohler Co.• Pfizer• American Home Products• AT&T• Chase Manhattan Bank• Eastman Kodak• Metropolitan Life Company• Sheraton New York

What about the ‘experts’ ...

• Tillinghast (June, 2001): Settlements will ultimately reach $200 billion with US insurers picking up $60 billion of the cost (up from ~$40 billion)

• A.M.Best (May, 2001): Total ultimate cost of resolving asbestos claims to US insurers of $65 billion

• Moody’s (January, 2001): “Asbestos claims looking to crash party of recovering P&C Insurers”

• Standard & Poor’s (August, 2001): “Asbestos claims pose significant but not catastrophic threat to US Insurers”

• Rand Institute for Civil Justice (August, 2001): Only Phase I of III. Spring 2002 is targeted date for release of later phases, including ‘likely magnitude and character of future litigation’.

Hope

Example Issues & Goals

• XYZ Corp. is named in numerous lawsuits and class actions relative to a product manufactured in the late 1950’s - late 1970’s, which contained asbestos material.

• Payments to date of up to $200 million, and the specter of unknown future claims and settlements has had a negative impact on XYZ shareholder value.

• Current insurance coverage may be sufficient to pay for all future claims…or maybe not. This uncertainty can be addressed in a financial insurance structure.

General Valuation Process

• Estimate number of future claims (to be reported in the future)• Historical Reporting vs. Exposure Analysis

• Estimate settlement pattern of current pending and future reported claims

• Estimate future settlement value of pending and future claims

• Develop structure of deductible (SIR or insurance), funding and possibly risk transfer coverage.

Exposure

Reported Claims

Settled Claims

Severity

Insurance

Key Initial Assumptions

• 1957-1977

• 232,000 through year end 2000

• 180,000 settled through 12/31/00, 52,000 pending as of 12/31/00

• Most recent years settling at $1,500 per claim (indemnity and legal) as average cost per all settled claims (with and without payment)

• Coverage available to handle up to $400,000,000 of current and future claims.

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Year Reported

Incr

emen

tal

-

50,000

100,000

150,000

200,000

250,000

Cu

mu

lati

ve

Incremental # Reported, By Year Cumulative # Reported, By Year

-

50.00

100.00

150.00

200.00

250.00

1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977

Year of Sale?

Sca

le

Cumulative Exposure (Sales?) Incremental Exposure (1967 peak)

When are claims expected from this exposure?

What is worst lag for lastexposure period?

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

2016

2018

2020

2022

2024

2026

2028

2030

2032

2034

2036

2038

2040

2042

2044

2046

2048

2050

Year Reported

Incr

emen

tal N

um

ber

Reported To Date High Estimate (440,000 more claims)

Medium Estimate (325,000 more claims) Low Estimate (240,000 more claims)

Average Cost per Claim, at various inflation rates

1,500

3,500

5,500

7,500

9,500

11,500

13,500

15,500

17,500

19,500

21,500

2000

2002

2004

2006

2008

2010

2012

2014

2016

2018

2020

2022

2024

2026

2028

2030

2032

2034

2036

2038

2040

2042

2044

2046

2048

2050

Year of Payment

Ave

rag

e C

ost

Per

Cla

im

1% inflation 2.5% Inflation 5% Inflation

Assumes average cost per claim(across all setllement) of $1,500in 2000 for indemnity & defense

Annual Payments under High/Low Band

-

10,000,000

20,000,000

30,000,000

40,000,000

50,000,000

60,000,000

70,000,000

80,000,000

Year of Payment

An

nu

al P

aym

en

t

Low Frequency (292,000 total claims to settle) and 1% inflation High Frequency (492,000 claims to settle) and 5% inflation

$459M total cost

$1.2B total cost

Blended Finite Risk Structure

• SIR or deductible can be linked to current insurance coverage, or can be built as indemnification of XYZ to act as ‘bridge’ loan while awaiting reimbursements from carriers.

• Without initial significant risk transfer, tax deductibility of insurance premiums less likely, but Commutation Account may be viewed as an asset, which can be monetized or used as leverage in borrowing.

• Risk Transfer element can grow as actual settlements come in ‘better than expected’. Adverse development can be linked to increased coinsurance or reduced Commutation percentage rather than Additional Premium amounts.

• ‘Optical’ coverage may result in market confidence that issue is now behind XYZ.

Period

Deductible/SIR

Limit

Adjustments

Premium

Example $700M Program•All claims reported to and unsettled by as of 12/31/00, and all future reportings relative to asbestos products liability.

•$400 million and 7 years.

•$300 million excess Deductible/SIR.

•Reference payment pattern established at policy inception. Actual settlement deviations from reference pattern result in (at XYZ’s option):

(1) Additional or Return Premium(2) Decrease or Increase in Commutation Percentage(3) Increase or Decrease in Risk Transfer layer Coinsurance

All adjustments based on formulas developed at program inception.

$80-$85 million

Sample Cumulative Payments

-

100,000,000

200,000,000

300,000,000

400,000,000

500,000,000

600,000,000

700,000,000

Year of Payment

Cu

mu

lati

ve P

aym

ent

Sample Cumulative Payments

Assume $400M covered by insurance,and would be exhausted by 2007

Program assumes $600M in payments, with a specificpayment pattern

$300M x $400M "Insurance" Program. $200M Funded, with $100M RT potential if actual first seven years performs "better'

Commutation

• Program is designed with significant Commutation feature, which allows XYZ to commute program with reasonable notice to carrier.

• Investment income credited to Notional Experience Account Carrier’s after tax yield (carrier takes investment risk), or High percentage of index specific (i.e. S&P 500, Dow 30,

etc.) returns with principal protection, or XYZ directed account…but here XYZ takes all investment

risk

Subject to credit review and approval, Experience Account may be allowed to run negative, in exchange for penalty interest debits to program, allowing additional liquidity to XYZ.

Commutation

• Commutation account can be assigned to a third party (financial institution) which may result in XYZ’s being able to borrow funds for this transaction at more attractive (closer to insurer’s) rates.

• Commutation is at XYZ’s option, resulting in contingent future income. Timing of commutation allows XYZ to better manage volatility.

• Commutation percentage (% of premium returned upon commutation) could float with actual experience to reflect better or worse than expected experience, and therefore more or less risk transfer.

Claim Information

Claims Handling

M&A

Data Needs & Open Issues

• Reported and Settled (number and $ value) by:

Type of Disease State/Jurisdiction of Suit/Class Action Plaintiff Law Firms Age of Claimant Occupation of Claimant

• Process can stay with current internal legal team and outside coordinating/panel counsel. Carrier can provide adjustment services if needed, and would require a measure of control commensurate with level of risk transfer.

• Can the program be designed to handle further mergers or divestitures?

Next Steps

• Develop better understanding of XYZ financial needs and economic motivations relative to asbestos exposure

• Capture data sufficient in scope and depth to be able to value current and future liability

• Design program to achieve XYZ goals, incorporating maximum flexibility in payment and coverage terms

• Detail key timelines and milestones to transact efficient and effective solution

Fear

“The next asbestos”’?

• Large number of ‘affected/infected’ individuals with specific occupations or targeted classes involved

• Large number of potential defendants (manufacturer, distributor, installer, etc.) with significant difficulty in determining which specific manufacturer or product was at root cause

• ‘Signature’ diseases

• Possibility for mass or ‘class action-like’ settlement

• Root cause material stopped being used/utilized due to known toxicity

• Long latency period

“The next asbestos”’? (I)

Toxic Mold

StachybotrysAspergillisChaetomiumPenicillium

• Erin Brockovich

• Home Builders Design, Materials, Installation or Environment

• Insurers Specific exclusion for mold under current policies

“The next asbestos”’? (II)

Lead (Paint)

• How can you ever tell one layer of paint from another?

• Children… Age of majority & the latency factor

• “It’s not the paint, it’s the…”: Lead in pipes Lead in gasoline

• “But we stopped putting it in paint in 1978” Just about the same time asbestos use was curtailed?

“The next asbestos”’? (III)

Arsenic Treated Wood (CCA)

• Outdoor wood (Decks) and Playgrounds Children again...

• EPA said there were “no unreasonable risks” to ordinary consumers but advised of precautions to those working with the wood

So if you make it, be careful, but if you play with it, it’s ok…? Environmental concern due to leaching of water runoff

• Wood Preservative Industry, Sellers (Home Depot, Loews), Municipalities