As discussed in more detail in the following paragraphs, the Company increased its reserves for asbestos liabilities significantly in each of 2005, 2004 and 2003. Asbestos liabilities are uniquely difficult to estimate due to both industry-wide issues and Company-specific factors. Industry-wide trends and factors have generally been adverse to insurance companies and include complex coverage issues, expansive judicial interpretation, lack of historical data, long reporting delays, substantial defense costs, increases in claims by unimpaired plaintiffs, venue shopping, bankruptcies of traditional defendants and targeting of peripheral defendants whose exposures may not be subject to aggregate policy limits. In developing its asbestos reserve estimates, the Company gives consideration to the current state of industry trends and factors, particularly those that most directly affect its policyholder universe such as the targeting of smaller, peripheral defendants. However, changes in these trends or the emergence of new trends or factors may not be reasonably foreseeable or their effects may not be reliably quantifiable as of the date of the Company’s estimate. Further, while industry trends have an effect on the Company, increases in the Company’s asbestos reserve estimates are most directly and significantly affected by changes in the state of asbestos claims against Crum & Forster’s specific policyholders. A comparatively small number of policyholders account for a substantial share of the Company’s asbestos claim payout activity in any given period and of the asbestos net unpaid losses and ALAE reserves at each balance sheet date. Changes in the conditions of specific policyholders, such as being targeted by plaintiffs in a state or states from which claims had not been previously filed or expected, adverse court decisions regarding coverage or defense obligations, the discovery (or allegation) of the existence of additional policies issued by the Company, the inability of another of the policyholder’s insurers to discharge its policy obligations, thereby increasing the obligations of the remaining insurers, can have a material impact on the previous estimate of the potential liability associated with that policyholder. These changes may not have been foreseeable or lacked sufficient credibility, even if foreseeable, as of the date of the Company’s previous estimate.
Due to the inherent uncertainties in estimating reserves for unpaid losses and LAE described above, and to the potential impact of recent trends, the ultimate liability for the Company’s loss and LAE reserves, and, in particular, its asbestos, environmental and other latent claims reserves, may vary substantially from the amounts currently reserved.
In 2005, the Company recognized net favorable prior year loss development of $60.5 million (6.8 loss ratio points) prior to amortization of deferred gains on retroactive reinsurance. The net favorable development was comprised of three principal components: (1) adverse development of asbestos, environmental and other latent liabilities of $44.6 million, primarily due to an unexpected adverse court decision related to one asbestos policyholder and largely offset by favorable emergence of non-latent umbrella and other casualty reserves in accident years 1998 and prior, (2) $24.7 million of strengthening of prior year reserves for the surety line of business, a line the Company exited in 2005, and (3) net favorable development of the Company’s remaining property and casualty reserves of $97.5 million, arising from accident years 1999 through 2004. Of the $97.5 million cited in (3) above, approximately 60% emanated from property and commercial multi-peril business and the balance from casualty business. Most of the property and commercial multi-peril development related to accident year 2004. The casualty lines generally developed favorably across all accident years in the 1999 through 2004 period with the exception of accident years 2001 and 2003 for general liability and accident year 2002 for worker’s compensation.
The ability of the Company’s insurance subsidiaries to pay dividends depends, among other things, on such subsidiaries having positive statutory earned surplus. The Company’s principal insurance subsidiaries are US Fire and North River. At December 31, 2005, US Fire reported statutory earned surplus of $261 million and North River reported statutory earned surplus of $32.5 million. On March 29, 2005, US Fire paid to the Company a cash shareholder dividend of $88.5 million. On April 14, 2005, North River paid to the Company a cash shareholder dividend of $4.9 million. On April 20, 2005, June 13, 2005, September 29, 2005 and December 12, 2005, the Company paid cash shareholder dividends of $22.5 million, $5 million, $40 million and $6 million, respectively, to Fairfax.
The remaining six equity securities have aggregate unrealized losses of $2,976 at December 31, 2005. Of this amount, $2,941 has been in an unrealized loss position for less than twelve consecutive months at December 31, 2005.
The Company’s investment portfolio includes investments accounted for using the equity method. These investments consist of equity interests of between 1.2% and 21.5% at December 31, 2005 with a total carrying value of $350,603 and $280,346 at December 31, 2005 and 2004, respectively, and are included in other invested assets on the consolidated balance sheets. For the years ended December 31, 2005, 2004 and 2003, earnings of equity method investees were $45,477, $24,402 and $13,640, respectively. Dividends received from all equity method investees were $4,766, $4,173 and $1,844 in 2005, 2004 and 2003, respectively.
In 2004, based on the Company’s internal actuarial review and an independent actuarial firm’s ground-up study of asbestos reserves, the Company strengthened its asbestos reserves by $90,515, principally in the general liability line. The asbestos reserve increase was driven mainly by an increase in the average severity of claims for known policyholders. Additionally, the Company increased its environmental reserves by $10,007. These reserve increases were offset, in part, by $20,000 of reserve decreases primarily in the general liability line for accident years 1997 and prior.
The Company uses tabular reserving for workers’ compensation indemnity reserves and discounts such reserves using an interest rate of 5%. The amount of related discount was $71,181 and $84,902 at December 31, 2005 and 2004, respectively.
At December 31, 2005, one prospective contract, covering accident years 2000 through 2002, has an unused limit available of $96,272 in the event the net loss and LAE ratio for accident year 2002, before the effect of this contract, exceeds 70%.