A.M. Best Special Report: The Impact of Significant Adverse Loss on Ratings of Property/Casualty Companies.

OLDWICK, N.J. -- A key driving factor of property/casualty rating downgrades over the past several years has been the impact of significant adverse loss and loss-adjustment expense (LAE) reserve development related to prior accident years, according to a special report released by A.M. Best Co.

The impact of adverse reserve development has been particularly significant in the commercial lines and reinsurance segments. As adverse reserve development is one of the leading causes of insurer insolvencies, reserve adequacy remains a critical rating issue for A.M. Best.

Large reserve charges have resulted in worse-than-expected operating performance and weakened capitalization of a number of insurance companies, often leading to ratings pressure and downgrades. Despite the considerable reserve charges, which totaled almost $47 billion over the past three calendar years, A.M. Best believes the industry's overall carried reserve position remains deficient.

A.M. Best believes the industry's reserves are deficient by as much as $67.0 billion, or approximately 19% of policyholder surplus. Of the $67.0 billion deficiency, $38.5 billion is related to unfunded asbestos and environmental (A&E) losses and $28.5 billion is related to core (non-A&E) loss and LAE reserves. These deficiencies have declined over the past several years, but they remain significant.

Representing 54% of the property/casualty insurance industry's total liabilities at year-end 2003, loss and LAE reserves play an integral role in determining a company's balance sheet strength. As an estimate of all future claim costs that have not yet been paid, a company's loss and LAE reserve is not only the largest but also the most difficult liability to estimate, particularly for long-tail lines of business where it may take 10 or more years to finally settle claims.

For casualty-oriented insurers, where carried reserves may be four or five times the size of policyholder surplus, a 25% reserve deficiency will render the company technically insolvent. For this reason, A.M. Best scrutinizes reserve adequacy in the rating process.

As the industry's reserve deficiency remains quite large, and despite the reserve charges in recent years, A.M. Best expects continued adverse reserve development in the near to mid term, particularly in the commercial lines and reinsurance segments. Also, a number of companies recently have completed or are in the process of completing ground-up A&E studies. Virtually all of the larger companies that completed these A&E studies increased their reserves for A&E losses, in some cases significantly. While market conditions generally have hardened for most lines of business, future reserve charges may severely impact the balance sheets and operating performance of some carriers. If unexpected, such charges would result in ratings pressure and downgrades.

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Nonsubscribers can download a PDF copy of the full special report (8 pages) for $50 or a combination of the PDF copy plus the spreadsheet file of the report data for $100 from our Web site at http://www.bestweek.com.

A.M. Best Co., established in 1899, is the world's oldest and most authoritative insurance rating and information source. For more information, visit A.M. Best's Web site at http://www.ambest.com.