Leading ratings agency Standard & Poor's yesterday said it had grave concerns that commercial insurers still had not reserved adequately for future claims for liabilities from business written in the past ? even though companies have seen their bottom lines hit badly in the last two years by not having set aside sufficient funds for claims.

This view prompted S&P to stick a 'negative' rating outlook on commercial insurers writing business in the US yesterday, after the industry collectively boosted reserves in 2002 and 2003 alone by $40 billion. That total was said to represent a 12 percent increase in reserve levels "in just two years".

In a report issued to outline the reasons behind the 'negative' outlook, S&P said it had serious concerns over not only on whether there was enough money set aside to pay for future insurance claims ? with insurers actually reducing some reserves last year by a combined total of $5 billion ? but also whether reinsurers will cough up the $100 billion that insurers say they are to recover.

The issue of reserves is something that hit a wave of corporations in the US, Europe and Bermuda ? with most of the Island's commercial insurers playing in the US market ? in 2002 and again, last year.

In that wave of reserve increases, the Island's two leading insurers put up millions more to shore up reserve levels.

XL Capital late last year took a $647 million charge against its fourth-quarter earnings. The charge followed its reviewing contracts sold between 1997 and 2001 by NAC Re Corp., an American reinsurance company XL bought for $1 billion in 1999.

XL made its move after claims against North American reinsurance contracts written in the late 1990s mounted, forcing it and others to pay out more than they had expected. But at the same time, the company offset the total reserve increase by reducing by $181 million, the funds it had set aside for potential claims in the September 11, 2001 terrorist attack on the World Trade Center, saying it has over-reserved in that case.

Earlier in 2003, ACE Limited also boosted its reserves when it took a $354 million charge to add the gross total of $2 billion to its reserves in for asbestos-related claims.

Yesterday, S&P noted in its report that "reserve shortfalls continue to plague US property & casualty (P&C) insurers despite their strong earnings reports in 2003". And the ratings agency said concerns about the low level of reserves, and the expectation that "reserves for old business will need further strengthening" led Standard & Poor's Credit Market Services to keep to a negative outlook for the sector.

There were also concerns voiced over the approach that insurers might take to reserving now that market conditions are softening, or prices going down as capacity (and competition) increase. Mark Puccia, credit analyst and managing director in Standard & Poor's Insurance Ratings group, said: "While some reserving error is explained by simple uncertainty, a good deal is caused by deliberate earnings management. This practice could land insurers in hot water, especially since the Sarbanes-Oxley Act took effect."

He added: "Insurers tend to under-report reserves during soft pricing periods and then build up the reserves as the market hardens," and said that S&P was relying on its own reserve modeling "to evaluate potential shortfalls that we expect companies to report in the future".

In 2002 and 2003 alone, commercial P&C insurers added more than $40 billion to their reserves, with major contributions for workers' compensation, medical malpractice, and commercial multiperil, yet the S&P said they also released $5 billion for the new 2002 accident year, which it said could turn out to be a "premature" move. Standard & Poor's backed up its concerns by saying recent projections by Morgan Stanley range as high as $60 billion, and that excludes reserves for asbestos and environmental claims which are both increasingly areas of concern, as lawsuit settlements and awards escalate into the region of $100 million and more.

The report added that "reinsurance represents a wild card. In aggregate, US commercial p/c insurers expect to recover about $100 billion from reinsurers, an amount that has steadily increased over the years as insurers write comparatively more long-tailed liability business. But given the increasingly contentious nature of reinsurance relationships, recoveries are anything but certain. Consistently conservative reserving practices will not likely come from within the industry."

"Only the combined force of regulators, investors, and the actuarial profession is powerful enough to break the habit of cycle-driven reserving," observed Steven Dreyer, managing director in Insurance Ratings at Standard & Poor's. "These parties must use their influence on the management of insurance companies to do the right thing. No one expects insurers to predict the future perfectly, but we do expect them to make consistent and reasonable judgments about claim costs."

The report concluded: "History indicates most commercial insurance companies have not met this standard. Standard & Poor's would like to see these companies learn from history, rather than repeat it."