St Paul Travelers’ downgrade raises fresh reserving doubts

THERE were fears yesterday of a further round of reserve-strengthening actions among major insurance groups after a leading analyst downgraded its investment rating on St Paul Travelers. 
 
Prudential Equity said its decision to downgrade its investment rating on St Paul Travelers to neutral weight from overweight was based in part on its belief that St Paul Travelers will have to take a loss reserve charge of between $250m and $500m in the second or third quarter of this year, largely to address surety and run-off issues at the former St Paul unit and the Gulf unit and surety business of Travelers. 
 
Last month Chris Winans, equity analyst at Lehman Brothers forecast that Ace Insurance, the Bermudian global insurance group, would see its 2004 earnings hit by a $400m addition to asbestos reserves towards the end of the year (ID, Jun 15). In 2003 several major insurance groups including XL Capital, AIG, Ace and The Hartford saw their earnings blighted to a greater or lesser extent by reserve-strengthening charges stemming from underpricing in the late 1990s. Although the Prudential Equity report acknowledged that a $250m to $500m charge for St Paul Travelers, equivalent to around $0.37 to $0.74 per share or 1.2% to 2.4% of book value, did not necessarily represent a huge hit, it noted that the combined insurance group would have to persuade investors and ratings agencies that it can deliver on its post-merger goals. 
 
For the first quarter the two units reported their earnings separately. Travelers took a $93.7m charge to strengthen prior-year reserves on certain of its run-off business, though this was partially offset by favourable prior-year developments in the property and commercial multi-peril businesses. The final reserve-strengthening bill was $28.1m. 
 
St Paul on the other hand saw its first-quarter earnings hit by both reserve-strengthening and reinsurance recovery reductions. It took a $53.2m after-tax charge relating to a reduction in an estimated reinsurance recovery, and a total of $42.3m after tax to strengthen international and reinsurance run-off business. St Paul also absorbed an after-tax charge of $28.5m related to a construction contractor in its surety operations, plus an after-tax charge of $16.2m for reserve-strengthening in several other lines of business. A spokeswoman for St Paul Travelers told Insurance Day yesterday that its policy is not to comment on analysts' reports. The Prudential Equity report, which focused on prospects for the property/casualty (p/c) industry, provided further suggestions that a full-blown market turn may be around the corner. The report's analyst, Jay Gelb, explained Prudential Equity is downgrading its view on the sector to neutral from positive because it feels commercial insurers are approaching a "negative inflection point on pricing, policy terms and conditions". And he predicted the commercial p/c market will enjoy a 12 to 18-month period of stability that will be followed by a "return to destructive competition". 
 
Mr Gelb wrote: "The commercial insurers should deliver solid book value growth for the next few years. This situation should offer a decent support level for the stocks, but not enough for us to maintain our favourable rating on the sector." He said personal lines insurers now have the edge over commercial insurers and brokers, and that was reflected in Prudential Equity's decision to downgrade its investment rating on St Paul Travelers and at the same time upgrade Safeco to neutral weight from underweight.