Issues & Trends with Asbestos (and other toxic/mass torts) Casualty Loss Reserve Seminar

1. Issues & Trends with Asbestos (and other toxic/mass torts) Casualty Loss Reserve Seminar September 11, 2001 New Orleans, LA Douglas W. Oliver, ACAS, MAAA, ARM Vice President & Director Corporate Solutions Division

2. Fear Hope Fear

3. Fear

4. 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?)

5. 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

6. 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

7. 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

8. 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

9. 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:

10. What do the following have in common?

11. What do the following have in common? Chiquita Pfizer Georgia-Pacific Kohler IBM

12. 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

13. 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’.

14. Hope

15. 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.

16. 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.

17. Key Initial Assumptions Exposure Reported Claims Settled Claims Severity Insurance • 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.

18. 40,000 250,000 35,000 200,000 30,000 25,000 150,000 Incremental Cumulative 20,000 100,000 15,000 10,000 50,000 5,000 - - 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Year Reported Incremental # Reported, By Year Cumulative # Reported, By Year

19. 250.00 200.00 150.00 Scale 100.00 When are claims expected from this exposure? 50.00 What is worst lag for last exposure period? - 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 Year of Sale? Cumulative Exposure (Sales?) Incremental Exposure (1967 peak)

23. 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.

24. Example $700M Program Period Deductible/SIR Limit Adjustments Premium • 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

26. 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.

27. 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.

28. Data Needs & Open Issues Claim Information Claims Handling M&A • 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?

29. 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

30. Fear

31. “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

32. “The next asbestos”’? (I) • Toxic Mold • Stachybotrys • Aspergillis • Chaetomium • Penicillium • Erin Brockovich • Home Builders • Design, Materials, Installation or Environment • Insurers • Specific exclusion for mold under current policies

33. “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?

34. “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