Asbestos Liabilities – The Continuing Saga

1. Asbestos Liabilities – The Continuing Saga Casualty Actuarial SocietyThe 2004 Seminar on Ratemaking Jennifer L. Biggs, FCAS, MAAA Towers Perrin Tillinghast March 11, 2004

2. Why So Much Litigation? • Large percentage of populationexposed • Signature diseases • Potential for large jury awards • Economies of scale for plaintiffattorneys • Insurance recoverables

3. The Asbestos Litigation Environment Has Changed • Increasing costs to defendants... • Surge in claim filings • Elevated settlement demands against individual defendants • Bankruptcies • ...and increasing costs to insurers and reinsurers • Higher costs for existing defendants • Additional costs for new defendants • Additional coverage accessed

4. Surge in Claim Filings

5. Change in Disease Mix

6. Increasing Numbers of Claimants Are Unimpaired 1982 4% of claims showed no manifest asbestos-related injury(RAND) 1993 Up to one-half of all asbestos claims have little or no physical impairment (Harvard Journal of Legislation) 1998 No evidence of disease in 57% of asbestos claims(Manville Trust) 74% of pending claims are unimpaired(confidential report prepared for a defendant) Two-thirds of claims show no evidence of impairment(Babcock & Wilcox) Vast majority of claims provide no evidence of impairment(W.R. Grace) 2001 Source: RAND

7. Other Trends in Claim Filing Activities Percent of filings in federal courts Source: RAND, January 2003

8. 100 MD Other states 80 TX 60 Percent IL NJ OH 40 MS PA WV 20 NY CA 0 Other Trends in Claim Filing Activities …and from some states to others Source: RAND, January 2003

9. Observations –Average Settlements by State

10. Observations – Disease Mix by State

11. Individual Claim Costs Also Increased • Mean verdicts to plaintiffs increased dramatically from 1998 to 2001 (RAND) • Mesothelioma: ~$2M to ~$6.5M • Other cancer: ~$1M to ~ $2.5M • Asbestosis: ~$2.5M to ~$5M • Damages paid by many individual defendants also increased dramatically, reflecting • increase in plaintiff awards • higher shares for remaining defendants

12. Frictional Costs in the System are High • According to RAND, transaction costs have consumed more than half of total spending • And they are likely to go back up in next decade 100 Plaintiff Compensation 80 60 Percent Plaintiff Expenses 40 20 Defense Expenses 0 1980s Litigation 1990s Litigation

13. Bankruptcy of Defendants • Currently approximately 72 bankruptcies of companies with asbestos-related problems, based on comparison of lists maintained by RAND, the American Academy of Actuaries and the Asbestos Alliance • Bankruptcy cited as “legislative solution” by Babcock & Wilcox • New bankruptcies may: • Increase costs for remaining defendants • Several defendants cited higher settlement demands as a cause of bankruptcy • Cause need for additional defendants • Approximately 300 asbestos defendants in early 1980s • Estimates of ~2,000 published a few years ago • RAND estimates over 8,400 today • Firms in current list of defendants span 75 of 83 possible 2-digit SIC industry codes

14. Number of Asbestos Related Bankruptciesper Year Note: Graph excludes a bankruptcy in 1976 and one bankruptcy for which no date is available.

15. Chapter 11 Bankruptcy • Re-organization by “debtor-in-possession” • Creditors’ committee(s) represent creditors in plan negotiation • Can seek court approval to prosecute claims of the estate (e.g., insurance coverage disputes) • Goal to agree upon a plan of reorganization that pays a fair portion of pre-petition claims and preserves the going concern value of the debtor • Insurance policies may be viewed as the most important asset of the debtor’s estate • Automatic stay bars all actions to obtain property of the estate • Where the debtor has a shared interest in a policy, claims against other insureds should also be stayed • Stay can be extended to related parties • Unaffiliated co-defendants have generally been unsuccessful in transferring their claims to the bankruptcy court • Under Code 524(g) Asbestos Trusts are established to pay current and future claimants • Can require >50% of debtor’s equity • Injunction channels all present and future claims to the trust for payment • Futures representative has no right to vote on the plan, but must be protected • The plan must be approved by a supermajority of 75% of current claimants Source: Mark D. Plevin/Crowell & Moring LLP

16. Can take years to complete1 File petition Negotiate with creditors File reorganization plan File disclosure statement Solicit votes Confirmation hearing Intended to be completed within a few months of filing Negotiated and voted on before filing Combined hearing to confirm Plan and Disclosure Differences Between Traditional and Pre-Packaged Bankruptcies Traditional Pre-Packaged • Insurance coverage generally exhausted or settled, or insurers included in negotiations • Insurers interests are not represented in pre-petition negotiations • Court appoints claimant representatives • Future’s Rep involved in negotiation for >50% equity • Plaintiff attorneys with large inventories negotiate terms that benefit their own clients, but do not owe a duty to all claimants • Commonly include a pre-petition trust to pay near full value on current claims • Matrix agreements with various plaintiff firms • Significant portion of equity can be secured (therefore not available to bankruptcy trust) 1 Johns Manville filed bankruptcy in 1982 and its plan was not confirmed until 1988; Babcock & Wilcox filed bankruptcy in 2000 and its plan has not yet been confirmed.

17. Pending “Pre-Packaged” Bankruptcies • Shook & Fletcher – 4/8/2002 • J.T. Thorpe Company – 10/1/2002 • Initially confirmed, but under appeal by two of J.T. Thorpe’s insurers • Combustion Engineering – 2/17/2003 • Objections filed by Century Indemnity (CIGNA) and Stonewall • Plan assigned rights to insurance policies to the trust • Congoleum Corp – 12/2003

18. Pending “Pre-Packaged” Bankruptcies • Halliburton subsidiaries – 12/16/2003 • Objections filed by several insurers including Ace, OneBeacon, Unigard, Stonewall, TIG, Hartford, Everest Re, Federal, Allianz • Plan caps the payments that healthy companies would make to future claimants • Designed to boost stock price by making Halliburton “asbestos free” • Global settlements of $4.25 B (PV) • Significantly increases compensation (7X) • Accelerates payment to current claimants • Intended to secure 75% approval • Negotiated without input from insurers, whose coverage will be called upon to pay most of the cost • Liberal, generous TDPs • Inadequate exposure requirements • Inadequate diagnostic requirements – No S/NS distribution • Do not require impairment for Level I-II claimants – Would not be compensable under laws of most states or federal common law • Futures representative, Professor Green • Selected by Halliburton and attorneys representing current claimants • Paid $9,000 “per diem” • 2/11/2004 – Judge Judith Fitzgerald denied insurers standing in the case and scheduled confirmation hearings for May 10-12, 2004

19. AC&S • Exemplifies several issues central to asbestos litigation today • Coverage disputes • Non-products claims • Bankruptcy proceedings • Findings of “self-dealing” plaintiff attorneys

20. AC&S • Background • Formed in 1958 • Installed asbestos-containing insulation in commercial and industrial settings until 1985 • First asbestos claims received in late 1970s • Insurance through at least 1980 did not contain asbestos exclusions • Primary coverage with Travelers and Aetna • Products coverage contained aggregate limits • Application of aggregate limits to non-products claims is disputed • Coverage disputes over last 20+ years • Ongoing between AC&S and Travelers • AC&S has settled with its other insurers • 300,000 claims valued at $3 billion remain at issue

21. AC&S • Pre-petition activities • During 2001, AC&S began to explore pre-packaged bankruptcy with Travelers and a “Pre-petition Asbestos Plaintiffs Committee” • AC&S represented by Gilbert Heintz and Sullivan (GHR) • Pre-petition committee chaired by Joseph Rice / Ness Motley • Late 2001, Travelers withdrew from negotiations • December 2001, GHR also took over claim settlements • Late 2001/early 2002, AC&S attempted to settle trial-listed and other asbestos BI claims for an assignment of insurance limits • April 2002, Travelers informed AC&S it would no longer provide coverage for asbestos claims

22. AC&S • Pre-petition activities • AC&S executed pre-petition trust agreement – April 2002 • Pre-petition committee selected trustee, Dan B. Lain • Agreed to five categories of secured claimants • A – paid prior to bankruptcy filing • Bx – partial payments; fully secured • By – partial payments; fully secured • C – fully secured • D – 75% secured; entitled to 50% of insurance proceeds • Remaining and future claimants unsecured; entitled to 50% of insurance proceeds • Without victory in Travelers coverage dispute, unsecured category unlikely to receive any compensation • Note: Per Judge Newsome’s brief, “…, no cogent explanation or rationale has ever been given for these categories or how claims held in certain law firms “inventories” were categorized. Notably, members of the pre-petition committee appear prominently in all of the secured categories.”

23. Independence vs. Conflicts of Interest? • From appointment of Kenesis (5/2002) until pre-package bankruptcy filed (9/16/2003), AC&S settled more than $2 billion of claims • Settlements over prior 20 years totaled $600 million • Pre-packaged plan stipulated that these settlements could not be challenged by the asbestos trust or AC&S AC&S • AC&S’ counsel for pre-packaged bankruptcy • Also negotiating AC&S claim settlements GHR Joseph Rice/Ness Motley Pre-petition Committee 70% Ownership • “Independent” claim reviewer • Paid $3M to review documentation of 250,000 Category D claimants • Purchased Clearing House in June 2003 Kenesis Pre-petitionTrust – Categories A, Bx, By, C, D ClearingHouse • Paid $2M as subcontractor of Kenesis • Sole proprietor, J. Benee Wallace, paralegal of Ness Motley

24. AC&S Plan Denied Confirmation • Travelers filed an objection to the AC&S plan on 11/26/2003 • Presented objections at a contentions 12/15/2003 confirmation hearing • On 1/23/04 Judge Newsome (Delaware federal bankruptcy court) denied confirmation of the AC&S pre-packaged bankruptcy plan, finding that the plan • Was not proposed in good faith • Unjustly prejudiced by plaintiff attorneys • Largely drafted by and for the benefit of the pre-petition committee through various pre-petition settlements • Unfairly favors one plaintiff over another • Fundamentally unfair that one claimant with non-symptomatic pleural plaques will be paid in full, while someone with mesothelioma runs the substantial risk of receiving nothing • Both should be compensated based on the nature of their injuries, not based on the influence and cunning of their lawyers “The court is informed that other judges have confirmed plans with such discriminatory classifications. This judge cannot do so in good conscience.”

25. Problems with Pre-Packaged Bankruptcies • Negotiated in secret by a select group of lawyers, whose clients receive preferential treatment relative to other claimants with similar disease • Future’s Representative bound by pre-petition settlements • Debtor is negotiating with insurers’ money • Conflicts of interest are abundant Source: Mark D. Plevin/Crowell & Moring LLP

26. How to Quantify Asbestos Liabilities? • Actuaries typically like to use past experience to predict the future • However, for asbestos we can’t use traditional actuarial methods (e.g., accident year loss development projections) • Long latency from exposure to disease manifestation • Potential involvement of multiple policy periods for individual claims

27. How to Quantify Asbestos Liabilities? • Many use benchmarks or rules of thumb • Market share techniques • For example, 5% of GL premium volume for affected years translates to 5% share of ultimate liabilities • Survival ratio techniques • equals ratio of total reserves divided by average annual payments • U.S. net asbestos survival ratio was 8.8 as of 12/31/2001 and 11.6 as of 12/31/2002 (excluding Fibreboard) • A.M. Best now using an undiscounted survival ratio of 18 - 20. • Aggregate development • multiples of paid losses, case reserves, or reported losses • Comparisons to peer companies (e.g., significant reserve additions)

28. How to Quantify Asbestos Liabilities? • Exposure-based modeling will improve understanding of ultimate A&E liabilities • For an insurer or reinsurer, it considers • Mix of insureds • Types of coverage • Policy wording • Attachment points and limits • Years of coverage • Claims handling and settlement activities • Greater understanding equips the defendant, insurer, or reinsurer to deal strategically with its exposure

29. Focused on total awards to plaintiffs • Estimated # future filings by disease • Estimated indemnity cost and trended by disease • Loaded for expense Top-Down • Focused on amounts paid by defendants • Assigned defendants to tier • Estimated # future filings, indemnity, and expense by tier • Allocated ultimates to year and compared to insurance coverage Bottom-Up Tillinghast – Towers Perrin Estimates of Ultimate Personal Injury Claim Costs • Tillinghast estimates ultimate loss & expense relating to U.S. exposure will be $200 billion • Two approaches:

30. Defendant Cost Retained Insured Direct – U.S. Direct – London Retained – U.S. Retained – London Ceded Ceded Other Other London London U.S. U.S. Allocate Ultimate Loss and ExpenseAmong Multiple Payers

31. Portion of $200 billion Ultimate Loss and Expense – Retained, Net Insured U.S., Net Non-U.S.** *$60 billion mid-point of $55 – $65 billion range of the “Universe” of net liabilities to the U.S. P/C market. **Additional details available in Emphasis 2001/3, “Sizing Up Asbestos Exposure,” a publication of Tillinghast – Towers Perrin, at www.towers.com.

32. Paid and Reported Loss and Expense Compared to Estimates of Net U.S. Ultimate Liability 80 80 70 70 60 60 50 50 $ Billions 40 40 30 30 20 20 10 10 0 0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Tillinghast 2001 Ultimate ($55-65 billion) Cumulative Paid ($26.0 billion at 2002) Estimated Reported ($52.0 billion at 2003) Outstanding Case & IBNR ($19.0 billion at 2002)

33. Recent Insurer Disclosures • There were several sizeable reserve increases during 2001-2002: • CNA – $1 billion pre-tax per A.M. Best; $750 million after tax (8/3/2001) • ECRA – $1 billion pre-tax estimated by A.M. Best (Feb. 2002) • The Hartford – reallocation of $540 million “all other” run-off reserves to asbestos (July 2002) • Chubb – $590 million by 12/31/2002 • St. Paul – $987.5 million settlement with Western MacArthur

34. Recent Insurer Disclosures • And the trend continues in 2003: • Travelers increased asbestos reserves (1/14/2003) • $3.22 billion gross, $2.55 billion net (exhausting remainder of Citigroup indemnification agreement) • disclosed major results of the study (policyholders with settlements, other policyholders, assumed reinsurance, unallocated IBNR) • ACE USA increased A&E reserves (1/27/2003) • $2.18 billion gross; $1.86 billion ceded • $354 million after-tax charge • Argonaut increased asbestos reserves by $52.8 million (March 2003)

35. Recent Insurer Disclosures • The Hartford increased asbestos reserves by $4.0 billion gross, $2.6 billion net ($1.7 billion after-tax) (5/12/2003) • Allstate: Q2&Q3 2003 net increase of $514M • Liberty Mutual: Q3 2003 increase of $405M gross, $331M net • CNA: Q3 2003 net increase of $517M for A&E and mass torts • AIG: Q4 2003 net increase of $440 - $450M • Chubb: Q4 2003 net increase of $250M • Increased pressure on peer companies to make similar disclosures

36. Recent Increases in Recognized Liabilities And around the world: • Chester Street • placed in provisional liquidation (Jan. 2001) • entered a “Scheme of Arrangement” (3/5/2001) • Equitas • £1.5 billion (gross-undiscounted) as initially undisclosed portion of total strengthening as of Q1 2000 • £1.7 billion (gross-undiscounted) as of Q1 2001 (July 2001) • No change as of Q1 2002 (July 2002) • £ 0.4 billion (gross-discounted) as of Q1 2003 (June 2003) • Royal & Sun Alliance • $538 million for U.S. and U.K. (Feb. 2002) • £150 million for U.S. and U.K. (Sept. 2003)

37. Rating Agency View

38. A.M. Best – Evaluation of Insurers’ Potential Asbestos Liabilities Unfunded Liabilities determined by • Market share indications • premium share or paid loss share (5 yr, 10 yr) • Indicated deficiency = Share x $65B – Cumulative Reported Losses • Cumulative Reported Losses = Cumulative Paid Losses (estimated pre-1992 + Note 29 1992 – 2002) + year-end 2002 Note 29 reserve • Three year survival ratio • Indicated Deficiency = (Target S.R. (20) – Actual S.R.) / Actual S.R. x net reserve • Final A.M. Best indication is judgmentally selected • If insurer has conducted a credible ground-up exposure based analysis • 20% weight to A.M. Best indication • 80% to high end of range from exposure-based review • Details of calculations available to individual insurers

39. And the costs extend beyond personal injury claims costs paid by defendants and their insurers... • “The Impact of Asbestos Liabilities on Workers in Bankrupt Firms” by Joseph E. Stiglitz, Jonathan M. Orszag, Detr R. Orszag – December 2002 • Bankruptcies across the nation • headquarters in 19 states • facilities in 47 states • Pre-bankruptcy, 200,000 workers employed by bankrupt firms • Loss of 52,000 – 60,000 jobs with each displaced worker losing an average of $25,000 – $50,000 in wages • Average 25% reduction to their 401(K) account (approx. $8,300 each) • Direct cost of bankruptcy: $850M – $1.7B

40. And the costs extend to the overall economy… • “The Secondary Impacts of Asbestos Liabilities,” NERA, 2002 • $2 billion of secondary impacts on the economy • For every 10 jobs lost due to an asbestos bankruptcy, the surrounding community will lose an additional 8 jobs • “Reducing the Asbestos Litigation Penalty: An Economic Benefit of Asbestos Reform Legislation,” Navigant Consulting Group, 2003 • Asbestos defendants pay an “asbestos litigation penalty,” increasing their borrowing costs and making it difficult/impossible for some firms to raise capital • Failure to enact legislation could reduce economic growth by $2.4 billion per year, costing 30,770 jobs annually • Extended over the 27 year timeframe contemplated by S1125 could mean 830,000 jobs will not be created and $64.8 billion in economic growth will be lost

41. Possible Federal Legislation • The Fairness in Compensation Act (H.R. 1283/S758) did not advance (1999–2000) • Would have established the Asbestos Resolution Corp. • Was opposed by President Clinton and the plaintiff’s bar • Likely prospective proposals supported by the Asbestos Alliance (led by the American Insurance Association and the National Association of Manufacturers) will focus legislation on four areas • Establishing objective medical criteria of asbestos-related impairment • Liberalizing statues of limitations • Eliminating consolidations • Eliminating forum shopping

42. Asbestos-Related Bills Introduced into the 108th Congress • 5 relating to asbestos reform • HR1114 – Kirk (R-IL) – office of Asb. Comp./court • HR1586 – Cannon (R-UT) – court • HR1737 – Dooley (D-CA) – court • S413 – Nickels (R-OK) – court • S1125 – Hatch (R-UT) – trust • 2 to ban the use of asbestos • HR2277 – Waxman (D-CA) • S1115 – Murray (D-WA) • 1 to change the tax code, such that asbestos-related settlement funds would be exempt from tax • HR2503 – Collins (R-GA)

43. Senate Bill 1125 • Preliminary negotiations involved insurers, defendants, and labor • Initially called for a privately funded trust totaling $108 billion comprised of: • Insurers - $45B • Defendant companies - $45B • Current bankruptcy - $4B • Voluntary contributions - $14B • Funding contribution • Insurers still negotiating; subject to insurer commission • Defendants grouped to tiers based on historical payments • Separated into sub-tiers based on revenues

44. Potential Insurer Allocation • Insurers include U.S. and Non-U.S. companies • Insurer funding is net of third party reinsurance • Gross of financial cover • Initial discussions based on a blended approach • Market share – premium and paid losses • Future exposure – carried reserves • Current discussions focused on an industry-wide ground-up study • Insurer funding is concentrated • 12 insurers likely to contribute 75% • 20 insurers likely to contribute 90%

45. Initial Quantification of the Economic Impactof S 1125 – 6/4/2003 Hearing • Is proposed Trust Fund of $108B adequate? • Tillinghast Projections Released May 2001: • $200B Ultimate Loss & Expense • Less $70B paid as of 12/31/2002 (est. by RAND) • Equals $130B of future payments • Reduced for frictional costs • $28B defense costs (21.5%) • $41B plaintiff attorney fees (40%) • $61B expected to reach claimants • Conclusion is consistent with RAND: transaction costs have consumed more than half of total spending

46. Initial Quantification of the Economic Impactof S 1125 – 6/4/2003 Hearing • Indemnity Awards under S 1125 = estimated claim filings x specific awards • Future claims to be be filed from 2003 - 2049 • Pending claims to be re-filed • Initially eight Disease Levels consistent with the Manville 2002 TDP • Specific awards by Disease Level • $0 for Levels I-II to • $750,000 for Level VIII (meso) • Collateral Offset ($0) • Medical Monitoring ($0.4 billion) • Tested various scenarios - all at or below $108B

47. Senate Bill 1125 - Compromises • S 1125 passed out Senate Judiciary Committee on July 10, 2003 (10-8) with significant compromises • Revised medical criteria – 10 Disease Levels • Revised awards ($20,000 for Level II to $1 million for Level X) • Increased funding • Demands of up to $153 billion = $135 billion from defendants and insurers plus $18 billion from existing trusts and other sources • Latest offer by business group and insurers is $114 billion • Defendant companies - $57.5B • Additional contingency fund - $10B • Insurers - $46B • Department of Labor to process claims

48. Is S 1125 a Good Deal for U.S. Insurers? • U.S. direct insurers could be allocated $28B* – undiscounted • U.S. vs. other (U.S. reinsurers and non-U.S.) allocation could change • If paid over 25 years, NPV ~ $17B – $20B • Indicated unpaid liabilities total $34B, implying $6B + savings • $34B = $60B projected ultimate less $26B paid at 12/31/2002 • Assumes all reinsurance is collectible • Without reform, $60B estimate could increase • Year-End 2002 carried net reserves were $19B • Estimate ~$24B, reflecting reserve increases throughQ4 2003 *U.S. insurers originally discussed funding of $27.3B/$45B

49. Potential Savings for an Individual Insurer • Savings results from: • Elimination of payments to the unimpaired • Specified awards by disease type • Reduction in frictional costs • Savings to individual insurers dependent on the allocation • Industry-wide ground-up study? • Savings would be proportional for an individual insurer if • Individual insurer reserves based on a ground-up exposure-based analysis • Consistent with results of an industry-wide ground-up study • Savings of 18% (= 100% – 28 / 34) • Assumes industry indicated liabilities of $34B

50. Current Status of S 1125 • Unresolved issues • Insurer allocation • Non-U.S. funding • Transition issues • Reinsurance pipeline • Solvency / Finality • Negotiations with labor • Days are numbered • Frist: Vows to bring legislation to the Senate floor last week of March or first week of April 2004 • Hatch: Proposes a 2-day negotiating session in mid-to-late March to focus on remaining issues