ACE Insurance’s recent announcement that it is increasing asbestos reserves by almost $300 million may be a case of too little, but perhaps not too late.
Rating agencies have been closely monitoring reserving practices, paying particular attention to the actual amounts set aside as compared to actuarial estimates of future liability. For the layman, this means the companies that determine the financial viability of insurers want to make sure they have set aside enough money to pay for future claims.
This is important stuff – insurance is predicated on the policyholder’s confidence in the insurer’s ability to pay claims. Any concern on the part of present or potential policyholders about this ability is going to hurt the insurance company’s ability to attract new customers.
While one would think the close monitoring of insurance company financials will provide ample warning of impending problems, history shows that when troubles hit insurers, they can collapse seemingly overnight.
In this case, AM Best, one of the leading rating agencies, believes ACE has not set aside enough cash to pay for future asbestos liabilities. Best goes on to say:
“A.M. Best expects that additional charges will need to be taken in the next several years. However, given ACE’s current capital levels and its substantial earnings projections, potential charges taken in subsequent years should be readily absorbed.”
Best did not reduce ACE’s rating. Fitch Ratings (my personal favorite) did cut its rating of an ACE’s subsidiary’s ratings from a B+ to a B- on concerns over future claims and the impact of the charge on overall financials.
Fitch has been very cognizant of the asbestos reserving issue, noting in their latest review of the industry a potential shortfall of $43-$60 billion in reserves for asbestos-related claims at the end of 2003.
While this may seem arcane, esoteric, and generally pretty uninteresting, asbestos reserving practices and results thereof are a key to the viability of many an insurer.
Those who buy insurance should take notice.

The Society for Human Resource Management released a report on the top trends that will affect US businesses in 2005. It comes as no surprise that health care costs led the way, with 57% of respondents naming this issue as the top management concern.
Compare this with a survey conducted last year on opinions of P&C insurance execs, who did not include health care costs in their top eight issues of the year.
Why? Is P&C insurance not affected by health care? No, actually one of the largest cost drivers of medmal, liability, workers comp, private and fleet auto, etc (P&C insurance lines) is health care.
Do P&C carriers have health care costs under control? No, a recent survey indicates medical inflation in one key P&C line is 12% annually, a rate that is significantly higher than overall medical trend.
So why the disconnect?
My guess, and it is only a guess, is a cultural inability to grasp the importance of medical trend. Most P&C insurance execs grew up in the business, viewing claims and the health care part of claims as financial numbers, and thus do not understand health care beyond its’ financial implications. It is viewed as a constant, a black hole, a great unknowable. I’ve heard one exec state “claims are claims, trend is trend”.
With this attitude, no wonder the trend rate is 12%.

The National Governors’ Assn is mounting a surprisingly united front in the battle with the federal government over Medicaid funding . Governors are complaining that the sum of currently proposed and possible federal changes to Medicaid may leave states unable to make up any funding deficit.
Medicaid accounts for 22% of the average state budget, pays for 50% of all long term care and 70% of nursing home costs. Total expenditures for 2004 are estimated at $360 billion, split equally between states and the federal givernment.
Some of the proposed changes look remarkably like the ones implemented in Utah under then-Gov. Mike Leavitt, recently nominated to head HHS. These include (thanks to California HealthLine):
–Allow states to make changes to Medicaid and SCHIP (child health), such as increasing copayments and limiting eligibility, without first obtaining federal waivers;
–Allow local officials to provide different benefits in different parts of a state; and
–Allow states to charge higher fees to higher-income recipients.
Why should the average insurance exec care? Well, this “stuff” usually flows downhill, which likely means cuts in Medicaid reimbursement to providers. Providers will seek to recoup this lost revenue from other sources, particularly those that are soft targets.
Smaller health plans, TPAs, and P&C carriers, take note.

Here are the top trends in health care as I see them, using the actuarial method of looking back over my shoulder to see what happened, and thereby predicting the future with confidence.
1. More consolidation amongst health insurers.
Many years ago (say, 8 or so) industry pundits were predicting that the health insurance industry would consolidate to a handful of large players, an oligopoly if you will. 2004 has added a lot of credibility to that argument, with Anthem-Wellpoint, Coventry-First Health, and United Healthcare-Oxford three of the more significant. The rationale behind these mergers is classic business school stuff – it is a mature industry, with limited growth opportunities, thereby favoring those companies with market power, economies of scale, and lots of capital/ready access to capital to grow by acquisition.
Expect more of the same in 2005.
2. The return of the hospital
Hospital expenses are the single most powerful driver of overall health care inflation, and they are showing renewed power. Weak hospitals, marginal managers, and bad business concepts have been driven out by the brutal forces of competition and reimbursement, leaving leaner, smarter, more aggressive institutions hardened by years of bargaining with managed care companies.
For now, hospitals hold the upper hand, and managed care firms are having a much tougher time at the negotiating table.
Expect this to remain the case throughout 2005.
3. Cuts in Medicaid and Medicare
Mr. Bush’s desire to reduce federal expenditures over the long term will result in significant changes in these behemoth programs. Health care costs are a huge portion of the federal budget, and present an attractive target to those focused on cutting deficits. Some of this is already apparent in the (latest) strident campaign to cut out “waste and abuse”.
There will very likely be tough cuts in hospital and physician reimbursement over the next two years, and perhaps a drastic overhaul of Medicaid in the form of block grants to states rather than the present “defined benefits” program model. When CMS shudders, the rest of the health care community quakes. These providers will look to recoup their lost revenue from somewhere…
Expect a very heated battle, with Bush et al eventually pushing through a drastic overhaul of these two “Great Society” programs.

Fitch Ratings has released its’ “final” analysis of the P&C industry’s results for 2003. The report focuses on reserve deficiencies, and while the results look better than those from a year ago, the overall message is troubling.
Here are the highlights and my comments in italics…
–total reserve deficiency at the end of 2003 was between $43 and $61 billion…the industry continues to be unable to predict future costs with any accuracy; this will give investors pause as they consider whether to provide funds to the P&C industry, leading (over the longer term) to capital constraints and therefore a tighter market
–most of this is due to under-reserving in the accident years 1994-2003, with the bulk between 1997 and 2002. historically poor reserving in this period has been due to a failure to predict the rise in health care costs. Many reserves for claims occuring in the late nineties assumed a health care inflation rate of 7-8%, an assumption that continues to drag down financial results, and has even contributed to the demise of several P&C carriers, including Atlantic Mutual.
–asbestos is responsible for between $15 and $25 billion of the total, reflecting the industry’s continued head-in-the-sand approach.
How do we put this in context?
1. The P&C market appears to be softening, with rates for short-tail lines (those where claims are usually reported within a few months of the end of the policy term) falling while longer term lines (liability, Workers’ Comp) leveling off or declining somewhat. This softening cannot continue if carriers are going to add to reserves – without higher premiums to make up the deficit, the reserve deficiency will continue to hang over the market.
2. Health care costs receive barely a mention in the Fitch report. Health care costs are the primary driver of most claims, and this lack of attention on the part of a premier rating agency and industry expert does not bode well for the industry as a whole – if they do not know what is causing the problem, they will not be able to address it. And the industry has not demonstrated ANY awareness of or commitment to addressing rising medical costs, even as trend rates in P&C exceed 12%.
3. Asbestos, asbestos, asbestos – the word that brings chills to the executive suite at many an insurer. Some carriers have “bitten the bullet”, while others seem to be adopting a “hope and pray” approach to dealing with their reserving problem. That approach, especially when viewed in the context of the softening market, will likely mean additional financial struggles for some P&C carriers and reinsurers.