Liability Storms and How to Quantify Their Effect

Casualty Actuarial Society

Seminar on Ratemaking

March 27, 2003

William R. Azzara

Gail Ross, FCAS, MAAA

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Outline

Overview of Liability ExposuresReasons to be Proactive and QuantifyA Method to Use

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Liability Exposures

AsbestosPollutionLeadPhen-FenConstruction DefectToxic Mold

TobaccoAlcoholFirearmsLatex SensitivityMTBE

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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

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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.

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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

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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

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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”

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Tobacco

Significant claim activity for manufacturers Some for distributors, advertisers, suppliers

Types of exposures include Private lawsuits Reimbursement actions

Government recovery of medical costsPrivate reimbursement actions

Class Action suits have been certified

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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

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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

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Lead

Contamination from lead paint & plumbingPrimary defendants include:

Building owners Paint and pigment manufacturers or distributors Plumbing manufacturers and distributors

Plaintiffs include government agencies and building tenants

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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

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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

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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

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Firearms

Products Liability actions are a recent phenomenon

Lawsuits include: Private and public recovery actions modeled after

government’s efforts against the tobacco industryAgainst defendants that include:

Manufacturers Retailers and Resellers Firearms Trade Associations

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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

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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

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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

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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

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MTBE

Alleged groundwater contamination from petroleum containing MTBE

Non-specific symptoms may lead to claimsPollution exclusion may not apply (Products

Liability)Government’s virtual mandate of use will

likely be used as a defenseRecent jury verdict against refiners in Lake

Tahoe drinking water contamination

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Other Developing Exposures

Advertising Injury / Intellectual Property Genetically Modified Crops Managed Care SV-40

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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

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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

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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

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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

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Method to Quantify

Management InterviewsDetailed Claim File Review to determine

Amount and Timing of LossesActuarial Projections using Company

Specific and Industry data to estimate IBNRReinsurance Considerations

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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

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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

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Method – File Review

Detailed Claim File Reviews (cont’d) Ultimate Losses include provisions for:

LossLoss ExpenseDJ ExpenseExpected Timing of Claim Payments

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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 ReportedProvision for unreported claims involving unknown insureds and unknown contracts for known claim types

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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 reviewAverage Ultimate Loss estimate is extrapolated over the Non-Target Claims to develop an estimate of Ultimate Losses for this group

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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 RatiosMarket Share Evaluation

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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?

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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

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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