Credit analyst favors Travelers over Ace due to asbestos exposure

By Ronda Fears

Nashville, Jan. 28 - Kathy Shanley, senior bond analyst at Gimme Credit, said that given Ace Ltd.'s boost to asbestos reserves she would prefer Travelers Property Casualty among issuers in the insurance group.

Ace (A2/A-) said Monday it will join Travelers Property Casualty and other major insurers in boosting reserves set aside to cover exposure to asbestos-related claims, making a $2.2 billion gross reserve addition although the after-tax impact will be a more moderate $354 million.

Shareholders responded favorably, in part because Ace also disclosed operating income for the quarter will come in ahead of Street estimates, but both Moody's Investors Service and Standard & Poor's put the company on watch for a possible downgrade.

"We would prefer to see Ace issue equity rather than the $300 million in debt or trust preferreds it is proposing, but the charge will have only a minimal impact on book value since it amounts to only about one quarter's earnings," shanley said in a report Tuesday.

"Ace won't release its earnings until next week, but based on the relative disclosure and provisioning for asbestos risk, we would favor Travelers over Ace, though we view both credits as weak single-A."

In addition to the asbestos risk itself, and the impact the charge will have on leverage ratios, the rating agencies are also concerned about Ace's outsized exposure to reinsurance recoverables, the analyst noted.

Ace's exposure to asbestos risk is a legacy of its 1999 acquisition of Cigna's property and casualty businesses, with a smaller part related to its 1998 purchase of Westchester Specialty from Talagen.

At the time of the acquisition Cigna agreed to indemnify Ace against unanticipated future losses but exercised an option to replace its guarantee with reinsurance from Berkshire Hathaway's National Indemnity Co. Cigna transferred $1.25 billion of assets in return for aggregate coverage of $2.5 billion.

In any event, litigation over the past year, including structured settlements and the proliferation of claims involving non-product exposures, not to mention the actions of competitors such as Travelers, required Ace to revisit its asbestos reserves.

Ace said the gross reserve addition of $2.2 billion is offset in part by amounts ceded to third party reinsurers - $1.3 billion - and NICO - $533 million. Ace is also setting aside $145 million as a bad debt provision against the reinsurance receivable, plus $53 million for its 10% remaining participation share, bringing the total charge to $516 million, or $354 million after-tax.

"The reserves put up by Travelers appear to be more conservative since 38% of the total reserve is classed as unallocated incurred-but-not-reported, versus only 27% for Ace," Shanley said.

"Ace uses a well-diversified pool of reinsurers, but the size of its reinsurance recoverable makes it more vulnerable to possible disputes or credit quality issues. Travelers is relying on reinsurance recoverables to cover only 21% of its gross asbestos reserve."

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