Liability Storms and How to Quantify Their Effect

1. Liability Storms and How to Quantify Their Effect Casualty Actuarial Society Annual Meeting November 11 & 12, 2002 William R. Azzara Bruce D. Fell, FCAS, MAAA, CFA

2. Outline • Overview of Liability Exposures • Reasons to be Proactive and Quantify • A Method to Use

3. Asbestos Pollution Lead Phen-Fen Construction Defect Toxic Mold Tobacco Alcohol Firearms Latex Sensitivity MTBE Liability Exposures

4. Pollution – Estimates are Stable • Slow growth in number of sites on the National Priority List • No dramatic changes in coverage case precedents, thereby encouraging settlements • Ongoing settlement activity has stabilized payment levels • Risk based corrective action has resulted in lower clean-up costs than originally expected by EPA • Greater PRP participation in site remediation – incentive to reduce / control costs

5. Pollution – Net U.S. Estimates • A.M. Best’s estimate of ultimate losses & ALAE = $56 billion • More recent estimates from other sources have been lowered to $30-$40 billion • A.M. Best believes that its estimate is still reasonably accurate, if not somewhat on the conservative side.

6. Phen-Fen • Diet drug manufactured by American Home Products (now Wyeth) • Serious health problems allegedly caused by product (e.g. heart valve and often fatal lung condition) • Wyeth settled large class for $3.5 billion but claims continue to be received • Wyeth recently added $910 million to its Phen-Fen reserve bringing total to $14+ billion

7. Construction Defect (CD) • “If you build it, they will sue” • Claims allegedly caused by negligence in the construction process • General construction • Toxic Mold • EIFS/Synthetic stucco • Claims have resulted in changes in practices by insurers • Pulling out of states • Eliminating classes of business

8. Toxic Mold • High profile exposure to industry is primarily due to First Party Coverages • Homeowners, Commercial Property, WC • Recent CA case resulting in $18 million in punitive damages in direct action against HO carrier • Limited claim activity from Third Party Coverages • If liability emerges in future, will the Pollution Exclusion apply? • Fitch recently concluded “Mold is not the next asbestos”

9. Tobacco • Significant claim activity for manufacturers • Some for distributors, advertisers, suppliers • Types of exposures include • Private lawsuits • Reimbursement actions • Government recovery of medical costs • Private reimbursement actions • Class Action suits have been certified

10. Tobacco • State medical cost recovery actions • Settlement of 46 states Medicaid actions • Payment of at least $206 billion • Includes changes in business practices • Voluntary settlement did not remove potential for future liability • Note recent CA verdicts of $28 billion and $3 billion respectively for two individual claimants • Insurance industry exposure remains uncertain

11. Tobacco • Foreign Exposure • Canada has several reimbursement actions pending (Quebec suing for $200 million) • EU, Colombia, Guatemala, Israel and others have also filed actions (Spain has first European local government action) • Australian market faces large class action suit • There may be no operable exclusions

12. Lead • Contamination from lead paint & plumbing • Primary defendants include: • Building owners • Paint and pigment manufacturers or distributors • Plumbing manufacturers and distributors • Plaintiffs include government agencies and building tenants

13. Lead • Frequency of claims has been less than the industry’s initial expectations • Plaintiffs have failed in certifying class actions • Landmark RI suit against lead paint industry recently ended in mistrial • Similar litigation filed by Chicago, Milwaukee, St. Louis & counties in TX and CA • Additional litigation possible in CT, WV, NJ, MA, NH and OH • Concern that Market Share Distribution of liability could result in significant costs • Lead paint remains in 330,000 private homes and public buildings in RI alone

14. Alcohol • Types of claimants: • Consumers of alcoholic beverages • Third parties injured by alcohol consumers • Victims of FAS (fetal alcohol syndrome) • Government agencies and health care providers who provide care for alcohol related injuries

15. Alcohol • Alcohol industry has successfully defended itself against all alcohol consumption suits, to date • Concern over products liability exposure similar to asbestos • No apparent contract exclusions • However, product warnings do exist

16. Firearms • Products Liability actions are a recent phenomenon • Lawsuits include: • Private and public recovery actions modeled after government’s efforts against the tobacco industry • Against defendants that include: • Manufacturers • Retailers and Resellers • Firearms Trade Associations

17. Firearms • Difficult to predict insurance implications due to recent activity • Several manufacturers have placed their carriers on notice • There are generally no specific applicable exclusions • Market Share Distribution of liability remains speculative but of concern for industry • Plaintiffs are watching a Brooklyn case in which it is alleged that manufacturers did nothing to prevent product misuse • Public appeal to have bullet shell “fingerprinting” by manufacturer

18. Latex Sensitivity • About 2.5% of the population is sensitive to the proteins contained in latex • Increased demand due to AIDS led to higher levels of protein in gloves • Hyper-sensitivity can cause skin and respiratory reactions leading to disability or death

19. Latex Sensitivity • Types of Claimants include: • Healthcare workers • Patients • The potential impact to the insurance industry appears manageable • Courts have generally frustrated the plaintiff bar’s attempts to certify class actions • Most courts now address product identification before allowing additional discovery

20. Methyl Tertiary Butyl Ether (MTBE) • Gasoline additive used as anti-knock compound (1979) and to improve combustion and reduce CO emissions (1992) • 1995 – mandatory “Reformulated Gasoline” use results in 30% of nationwide gasoline sales contain MTBE • Use of MTBE will stop in 2003-CA to delay • Identified as a possible carcinogen

21. MTBE • Alleged groundwater contamination from petroleum containing MTBE • Non-specific symptoms may lead to claims • Pollution exclusion may not apply (Products Liability) • Government’s virtual mandate of use will likely be used as a defense • Recent jury verdict against refiners in Lake Tahoe drinking water contamination

22. Advertising Injury / Intellectual Property Genetically Modified Crops Managed Care SV-40 Other Developing Exposures

23. The Problem • Industry estimates of liability from latent exposures are significantly higher than the sum of amounts disclosed by companies • Some companies: • Are slow to identify/quantify latent exposures • Are under-reserved • Have elected the business strategy of recognizing the liabilities as claims develop

24. The Problem • Quantitative Effects • Immediate and direct effect on current earnings and equity/surplus of reflecting liability • Uncertainty of future earnings drag if future costs exceed established reserve • Qualitative Effects • Management abilities questioned • Mergers & Acquisitions limited by uncertainty

25. What is Needed • Identification of Exposure • Coverages that might result in exposure • Time span coverage was afforded • Quantify Ultimate Cost • Potential frequency • Potential severity • Timing of future claim filings & payments • Potential defense costs

26. Method to Quantify • Determine a company’s Latent Loss Liability using: • Company’s own data • Claim Specialists with working knowledge of Latent Liability Losses • Industry-wide data

27. Method to Quantify • Management Interviews • Detailed Claim File Review to determine Amount and Timing of Losses • Actuarial Projections using Company Specific and Industry data to estimate IBNR • Reinsurance Considerations

28. Method – File Selection • Target Claims selected for review based on: • Current reserve size • Presence of Declaratory Judgment (DJ) reserves • Defendant name recognition • Loss Type – Asbestos, Pollution, etc. • Claim Status – Open, Closed, Re-open • Year – Accident, Policy, or Underwriting • Random Claims – selected from remaining population

29. Method – File Review • Detailed Claim File Reviews • End-of-Day Ultimate Losses are estimated on a claim-by-claim basis for Target and Random Claims • Ultimate Losses are based on Industry Experience and the working knowledge of claim specialists

30. Method – File Review • Detailed Claim File Reviews (cont’d) • Ultimate Losses include provisions for: • Loss • Loss Expense • DJ Expense • Expected Timing of Claim Payments

31. Method – IBNR Estimate • Provision for IBNR (Incurred But Not Reported) is split into two components: • IBNER – Incurred But Not Enough Reported • Additional amount of reserve for known and unknown claims involving known insureds, known contracts and known/reported claim types • IBNYR – Incurred But Not Yet Reported • Provision for unreported claims involving unknown insureds and unknown contracts for known claim types

32. Method – IBNER Estimate • Estimate utilizes the results of: • Target Claims file review • Random Claims file review • Loading for remaining claims based on Random Claim file review • Average Ultimate Loss estimate is extrapolated over the Non-Target Claims to develop an estimate of Ultimate Losses for this group

33. Method – IBNYR Estimate • Provision for IBNYR Losses based on: • Industry estimates of Ultimate Losses • Claim Specialists’ estimate of “stage of development” for the particular book • “Traditional” Actuarial Approaches • Survival Ratios • Market Share Evaluation

34. Method – Reinsurance • Using a sample of claim files, the relationship of reinsurance to direct/gross liabilities is determined • Intended vs. collected cessions • Based on these relationships, any ceded reinsurance liabilities are determined • How much uncollectible reinsurance?

35. Advantages of Method • Analysis performed at claim level • Source of exposure and differences in claim estimates can be pinpointed to specific types of claims, claimants, policies, etc. • Uses fewer global assumptions • Can more effectively quantify the qualitative aspects and uniqueness of the book

36. Advantages of Method • Claim Specialists perform a large part of the review • Hands-on experience enables more accurate estimate of potential exposure by tailoring analysis to specific factual damage and coverage information involved at claim level • Specific consideration of development stage and timing • Actuaries are involved where global assumptions are made