Property-Casualty Insurers Take
Charges to Boost Claims Reserves

Investors largely are shrugging off a massive wave of fourth-quarter charges to boost claims reserves in the property-casualty insurance sector, though Wall Street and ratings-agency analysts say few accounting maneuvers illustrate so well the opportunity that managements have to manipulate certain reserves to their advantage.

So far this quarter, more than three dozen insurers have reported, or say they will report, a total of $5.4 billion in charges mostly related to either restructuring or claims reserves. Insurance companies set aside some of the premiums they collect as reserves for future losses, and charges to strengthen reserves for claims from policies sold in past years is the biggest single category, at $2.1 billion.

Most are making up for under-reserving in the late 1990s as a price war waged and companies were hard-pressed to stockpile for future claims. To the critics, the mass action is a sign of the malleability of insurance accounting, which allows discretion in how such reserves are set up. And many insurers see this as a good time to take remedial action, they say. Why? Third-quarter charges for claims related to the Sept. 11 terrorist attacks already have made 2001 a lost cause.

Wall Street analysts refer to the current earnings season as the "kitchen sink" quarter. Alice Schroeder, a property-casualty analyst at Morgan Stanley, writes in a report that the reserve boosts amount to an "industrywide confessional and rush to atone." She says many of the revelations "amount to delayed recognition of problems of which, in some instances, managements were most likely aware, but did not report timely."

She says the cumulative impact of the under-reserving on earnings and growth trends, "if spread back to the accounting periods in which they originally arose, frequently could be significant." An equally important but "unanswerable question" raised by the "unprecedented wave of writeoffs," she says, is whether "the industry will permanently reform or (more likely) embark, once again, on a slow but steady process of digging a brand-new hole of equal depth and breadth" from which it would ultimately have to climb.

Still, even though the collapse of Enron Corp. with its accounting irregularities may be in the backs of their minds, investors are largely unfazed, focusing instead on the insurance sector's improved prospects for the next few years. Coming off the price war, underwriters have been locking in strong rate increases in recent months, aided by certain capacity shortages that the costly Sept. 11 attacks exacerbated. Shares of W. R. Berkley Corp. are up 4.5% since it announced a $55 million claims-reserve boost earlier this month, while those of St. Paul Cos. have climbed 3.2% since it announced a $612 million reserve boost in mid-December; in contrast, the S&P 500 index is down 3.5% since then.

"You pick up the paper every day and everyone is talking about 30% rate increases, 100% rate increases," says Michael Frinquelli, a partner at Renaissance Fund Advisors, a New York investment firm that specializes in insurance stocks. "If they got to where they're supposed to be with the reserve increases, it should be a very good year for earnings."

Eugene Ballard, chief financial officer of Berkley, says the increases for the Greenwich, Conn., property-casualty insurer were related primarily to the 1998 and 1999 underwriting years. "People think it's a good time to be cautious with their reserve positions," he says, adding that the reserve boosts largely were related to reinsurance contracts written in 1999 that saw significant claims increases last year. He says they weren't deficiencies that Berkley had been aware of earlier, thus they don't fit the kitchen-sink characterization. Among other insurers to take big reserve boosts: Chicago-based CNA Financial Corp., with a $229 million increase. CNA declines to comment. In its news release, the company said $69 million of the increase was related to the 2001 accident year and the rest was related to year-2000 underwriting at its U.K. reinsurance subsidiary.

Cynics say some companies also may be trying to wrap as many expenses into the hopeless fourth quarter as they can, aiming to improve profit margins in 2002. "What they're trying to do is stuff their earnings for 2002," says Don Watson, director at Standard & Poor's insurance-ratings group. "The market is going to be more tolerant of reserve hits for 2001. With the type of premium-rate increases they're seeing now, poor results won't be tolerated in 2002."

Some analysts say other companies may be building up bigger-than-necessary reserves in moves that could boost earnings years down the road. William Yankus, a property-casualty analyst at Fox-Pitt, Kelton, calls St. Paul's $612 million claims-reserve boost, largely related to its exit from the medical-malpractice insurance business, "extremely conservative," meaning it appears that St. Paul has reserved more than required by insurance regulators. "This is an extreme case of righting the ship for the future," he says, noting that St. Paul appears to be giving itself plenty of room to possibly release some reserves in future years, a move that would aid its bottom line in those years to come.

"We were interested in making sure that we had the medical issue behind us," says Tom Bradley, St. Paul's chief financial officer, maintaining it wasn't management's intention to over-reserve, but a case of management being conservative with its estimates. St. Paul set aside big reserves for its medical-malpractice business before, in the late 1980s and early 1990s, and reduced them by a total of $1.1 billion between 1992 and 1998, according to Blair Sanford, an analyst at investment bank Cochran-Caronia.

In many cases, "the industry was deluding itself" over the past few years about adequacy of its reserves, says Dirk Lohmann, group CEO of Converium Ltd., a Zurich reinsurer. Companies were "taking an optimistic view" of future exposure."

Write to Christopher Oster at chris.oster@wsj.com¹

Updated February 26, 2002