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Concerns linger about USF&G;'s financial state

THE BALTIMORE SUN

NEW YORK -- While USF&G; Corp. hasn't thrilled anyone with its recent losses and frayed investment portfolio, of greater concern is the unknown muck that may still be leaching through the company.

Most of the harsh glare focused on USF&G; stemmed first from the market's trouncing of its stock -- despite the company's assertions of strength -- and then later from the bleak numbers it revealed in quarterly reports. Not only was operating performance poor, but some losses on investments included in financial footnotes were not included on the bottom line, meaning the results were worse than they appeared.

If that wasn't enough, the resignation of its chief executive officer was more worrisome still, since chief executive officers of major embattled U.S. corporations don't tend to step aside when a rebound is imminent.

Well, the stock market is still dubious about USF&G.; The company's yield is more than 13 percent, about three times average, meaning further dividend cuts are expected, meaning the company's long-term profitability is still in doubt, meaning still more problems are expected to emerge.

An area that stands out as ripe for concern is the adequacy of loss reserves for future claims on current or past policies. Deficiencies in this area are impossible for outsiders to detect and often hard even for insiders to detect. They can remain buried for years, though there's an inevitable worming to the surface.

Based on an analysis of USF&G;'s record, the existence of those problems would hardly be a surprise. According to an industry study covering 1984 through 1989 that is to be released this week by the credit-rating agency Fitch Investors Services, the core property and casualty division of USF&G; -- to compensate for underestimating the scope of claims -- increased its loss reserves annually by an amount averaging 17.1 percent of its surplus level at the end of the prior year. USF&G; declined comment until it had received the report.

"Surplus" is accounting jargon for what is known as equity in other industries. It is so named because if all values on an insurance company's balance sheet are correct, it is what is left over after all obligations are covered.

For policyholders and the company itself, it is the key buffer between unfortunate occurrences and disaster. For the company's owners, surplus is essentially the company's net worth, so its cushioning qualities are limited. Any reduction at all is painful.

Questions about USF&G;'s capital adequacy aren't new. Speaking Thursday in New York to a packed industry conference sponsored by Coopers & Lybrand, USF&G; Vice President Kathleen F. Wycoff said an annual visit from a credit-rating agency was normal, but in the past two years Standard & Poor's had visited USF&G; eight times.

USF&G; is hardly the only insurance company to prompt concerns. Alan Levin, Standard & Poor's senior vice president, told the conference, "This industry has not gained a reputation for accuracy in assessing liabilities."

The Fitch survey, which covered 50 of the largest property and casualty insurers, concludes that those companies annually swallowed average losses equivalent to 7.1 percent of surplus to cover losses from past policies. USF&G; ranked No. 38 -- with No. 50 the worst. No. 39 was Maryland Casualty Co., the Baltimore-based subsidiary of the Zurich-American Insurance Group.

In part, the industry's tendency to misestimate losses can be blamed on the nature of the business. "Property-casualty insurers are probably the only firms that must set the selling price of their product before they know the cost of goods sold," remarked Fitch analyst David Wells, who wrote the report.

Even under ideal circumstances, establishing a framework for pricing requires factoring in a future that encompasses strange circumstances such as hurricanes or idiosyncratic juries.

New obligations for old problems seem to arise annually, the most recent being a court decision making insurers responsible for environmental cleanups.

Nonetheless, the process of assessing those risks is the art and science of the business. The consequences of charging too little or prematurely scooping out too much because of expected profits is the same as in any business. If the disparity is large, the business will, in effect, self-liquidate.

Accuracy in this regard is "to a degree . . . [an indication of] how competent the insurer has been in underwriting," wrote Mr. Wells.

Moreover, he added, "an insurer's track record in estimating losses is an important first step in determining the confidence one should have in that company going forward. Adverse reserve developments mean not only that past profits were overstated and capital overstated, but that future profits will be lost and capital reduced to pay for reserve strengthening. Inaccurate reserving decisions also lead to mispricing of an insurer's current business."

Though no company can be accurate every year, the Fitch review suggests that companies have basic tendencies toward being aggressive or cautious. USF&G; ranks on the aggressive side. According to the study, it revised reserves upward every year except 1989. Maryland Casualty underestimated losses every year.

Only eight companies were, on average, overcautious throughout the time period covered by the study. Interestingly, the best, Ohio-based Progressive Corp. and the third-best, Washington, D.C.-based GEICO Corp., underwrote opposite ends of the same industry.

Progressive insures what are politely known as "substandard drivers" and GEICO only the drivers with the cleanest records. That suggests that the likelihood of the policyholders' registering claims is less significant than the practices of the insurer in reserving for potential losses.

Additionally, Mr. Wells points out, insurers were most inaccurate in years when premium revenues (and consequently profitability) was poor. For both the industry and USF&G;, the most significant revisions were for 1985, a year in which USF&G; lost $258 million and the overall industry was in the tank. The years 1986 through 1988 were far better, and both the industry and USF&G;'s increase in reserves for 1987 through 1989 were more modest.

Insurers, of course, could be merely becoming more adept at reckoning risk. On the other hand, they may not -- and given history, it's a good bet they are not.

Conditions softened in 1988 and have since gotten worse. It will take several years to see whether under-reserving has increased, though it wouldn't be a surprise. Some companies have materially changed how they do business, and the past may not be a good indicator of the future.

Poor past results, he said, "are just a starting point . . . [for which] tougher questions should be asked in the future."

But the exceptional cases are rare. "My experience has been that things don't change that fast in insurance," Mr. Wells concluded.

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