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."