18. LIABILITIES FOR OUTSTANDING CLAIMS, LOSSES AND LOSS ADJUSTMENT EXPENSES

The Company regularly updates its reserve estimates as new information becomes available and further events occur which may impact the resolution of unsettled claims. Reserve adjustments are reflected in results of operations as adjustments to losses and LAE. Often these adjustments are recognized in periods subsequent to the period in which the underlying policy was written and loss event occurred. These types of subsequent adjustments are described as "prior year reserve development". Such development can be either favorable or unfavorable to the Company's financial results and may vary by line of business.

The table below provides a reconciliation of the beginning and ending reserve for the Company's property and casualty unpaid losses and LAE as follows:


FOR THE YEARS ENDED DECEMBER 31	2010			2009			2008
*(In millions)*
Reserve for losses and LAE, beginning of year	$	3,152.1		$	3,201.3		$	3,165.8
Incurred losses and LAE, net of reinsurance recoverable:
Provision for insured events of current year ⁽¹⁾		1,966.4			1,793.5			1,784.6
Decrease in provision for insured events of prior years		(111.1	)		(155.3	)		(159.0	)

Total incurred losses and LAE		1,855.3			1,638.2			1,625.6

Payments, net of reinsurance recoverable:
Losses and LAE attributable to insured events of current year		1,077.8			970.9			999.9
Losses and LAE attributable to insured events of prior years		738.6			788.5			712.4

Total payments		1,816.4			1,759.4			1,712.3
Change in reinsurance recoverable on unpaid losses		48.3			72.0			(11.9	)
Purchase of Verlan Fire Insurance Company		—			—			4.2
Purchase of AIX Holdings, Inc.		—			—			129.9
Purchase of Campania Holding Company, Inc.		36.5			—			—

Reserve for losses and LAE, end of year	$	3,275.8		$	3,152.1		$	3,201.3

(1)	Includes unfavorable reserve development related to catastrophe losses of $4.1 million, $7.0 million and $0.7 million in 2010, 2009 and 2008, respectively.

As part of an ongoing process, the reserves have been re-estimated for all prior accident years and were decreased by $111.1 million, $155.3 million and $159.0 million in 2010, 2009 and 2008, respectively. Prior year loss reserve development in 2010, 2009 and 2008 was favorable by $88.5 million, $133.1 million and $154.4 million, respectively. Prior year LAE reserve development was favorable by $22.6 million, $22.2 million and $4.6 million in 2010, 2009 and 2008, respectively.

The favorable loss reserve development during the year ended December 31, 2010 is primarily the result of lower than expected severity in the personal automobile line across all coverages and lower frequency in the personal automobile line in property coverages, primarily related to the 2009 accident year, and lower than expected frequency in the workers' compensation line, primarily related to the 2008 and 2009 accident years. In addition, lower than expected severity in the commercial multiple peril line in liability coverages, primarily related to the 2007 through 2009 accident years and in the commercial umbrella line related to the 2007 through 2009 accident years contributed to the favorable development, partially offset by unfavorable development in our bond line, primarily related to the 2009 accident year.

The favorable loss reserve development during the year ended December 31, 2009 is primarily the result of lower than expected severity of bodily injury in the personal automobile line, primarily in the 2005 through 2008 accident years, lower than expected severity in the workers' compensation line, primarily in the 2000 through 2008 accident years and lower than expected severity in the commercial multiple peril line, primarily in the 2005 through 2007 accident years. In addition, lower than expected severity in the bond line, lower projected losses in our run-off voluntary pools and lower projected exposures to asbestos and environmental liability for our direct written business contributed to the favorable development. Partially offsetting the favorable development was unfavorable non-catastrophe weather-related property loss development, primarily related to our homeowners, commercial property and personal automobile physical damage lines, which developed unfavorably by $6.8 million, $6.7 million, and $1.6 million, respectively.

The favorable loss reserve development during the year ended December 31, 2008 is primarily the result of lower than expected severity of bodily injury in the personal automobile line, primarily in the 2003 through 2007 accident years, and lower than expected severity of liability claims in the commercial multiple peril line for the 2002 through 2007 accident years. In addition, lower than expected severity in the workers' compensation line, primarily in the 2003 through 2007 accident years, contributed to the favorable development.

During the years ended December 31, 2010, 2009 and 2008, estimated LAE reserves for claims occurring in prior years developed favorably by $22.6 million, $22.2 and $4.6 million, respectively. The 2010 amount includes $9.8 million of favorable development resulting from a change in the cost factors used for establishing unallocated loss adjustment expense reserves. The favorable LAE development in 2010 is also attributable to improvements in ultimate loss activity on prior accident years, primarily in the commercial multiple peril, personal automobile, and workers' compensation lines. In 2009, the Company changed its unallocated loss adjustment expense reserving methodology from that based on cash payments to that based on unit costs, which resulted in a $20.0 million benefit, of which $16.0 million related to prior years. The Company believes that the methodology based on unit costs is more representative of its future costs of settling existing claims. The favorable LAE development in 2008 is primarily attributable to improvements in ultimate loss activity on prior accident years, primarily in the commercial multiple peril line.

The Company may be required to defend claims related to policies that include environmental damage and toxic tort liability. The table below summarizes direct business asbestos and environmental reserves (net of reinsurance and excluding pools).


FOR THE YEARS ENDED DECEMBER 31	2010			2009			2008
*(In millions)*
Reserves for losses and LAE, beginning of year	$	11.3		$	18.5		$	19.4
Reductions in losses and LAE		(0.4	)		(7.1	)		(2.3	)
(Paid) reimbursed losses and LAE		(0.8	)		(0.1	)		1.4

Reserves for losses and LAE, end of year	$	10.1		$	11.3		$	18.5

Ending loss and LAE reserves for all direct business written by the Company's property and casualty companies related to asbestos and environmental damage liability, included in the reserve for losses and LAE, were $10.1 million, $11.3 million and $18.5 million, net of reinsurance of $19.9 million for both 2010 and 2009, and $13.9 million in 2008. During 2010, the Company reduced its asbestos and environmental reserves by $1.2 million due to several small settlements. In recent years, average asbestos and environmental payments have declined modestly. As a result of the declining payments, the Company's actuarial indicated point estimate of asbestos and environmental liability reserves was lowered resulting in favorable reserve development of $7.1 million during the year ended December 31, 2009. During 2008, our asbestos and environmental reserves decreased by $0.9 million, primarily due to a favorable cash recovery from a reinsurer on a prior year environmental claim. As a result of our historical direct underwriting mix of Commercial Lines policies toward smaller and middle market risks, past asbestos and environmental damage liability loss experience has remained minimal in relation to our total loss and LAE incurred experience.

In addition, and not included in the numbers above, the Company has established loss and LAE reserves for assumed reinsurance pool business with asbestos and environmental damage liability of $33.9 million, $45.6 million and $58.4 million at December 31, 2010, 2009 and 2008, respectively. These reserves relate to pools in which the Company has terminated its participation; however, the Company continues to be subject to claims related to years in which we were a participant. Results of operations from these pools are included in the Company's Other Property and Casualty segment. The $11.7 million decrease in these reserves during 2010 was primarily due to a large claim settlement within these pools. A significant part of our pool reserves relates to the Company's participation in the ECRA voluntary pool from 1950 to 1982. In 1982, the pool was dissolved and since that time, the business has been in runoff. The Company's percentage of the total pool liabilities varied from 1% to 6% during these years. The Company's participation in this pool has resulted in average paid losses of approximately $2 million annually over the past ten years. During the year ended December 31, 2009, the Company's ECRA pool reserves were lowered by $6.3 million as the result of an actuarial study completed by the ECRA pool manager. Management reviewed the ECRA actuarial study, concurred that the study was reasonable, and adopted its actuarial point estimate. In addition, during the year, management recorded favorable development of $4.3 million on a separate large claim settlement within these pools. Because of the inherent uncertainty regarding the types of claims in these pools, the Company cannot provide assurance that our reserves will be sufficient.

The Company estimates its ultimate liability for asbestos, environmental and toxic tort liability claims, whether resulting from direct business, assumed reinsurance and pool business, based upon currently known facts, reasonable assumptions where the facts are not known, current law and methodologies currently available. Although these outstanding claims are not significant, their existence gives rise to uncertainty and are discussed because of the possibility that they may become significant. The Company believes that, notwithstanding the evolution of case law expanding liability in asbestos and environmental claims, recorded reserves related to these claims are adequate. The asbestos, environmental and toxic tort liability could be revised in the near term if the estimates used in determining the liability are revised, and any such revisions could have a material adverse effect on our results of operations for a particular quarterly or annual period or on our financial position.

On January 2, 2009, the Company sold its remaining life insurance subsidiary, FAFLIC, to Commonwealth Annuity, a subsidiary of Goldman Sachs. Coincident with the sale transaction, Hanover Insurance and FAFLIC entered into a reinsurance contract whereby Hanover Insurance assumed FAFLIC's discontinued accident and health insurance business. In addition to the property and casualty reserves, the Company also has liabilities for future policy benefits, other policy liabilities and outstanding claims, losses and LAE as well as the related reinsurance recoverables, all of which relates to the Company's assumed accident and health business in 2009, as well as for a majority of these liabilities in 2008. These reserves are reflected in the balance sheet as liabilities and assets of discontinued operations. The cumulative liability, excluding the effect of reinsurance that consists of the Company's exited individual health business and its discontinued accident and health business, was $129.7 million and $130.5 million at December 31, 2010 and 2009, respectively. Reinsurance recoverables related to this business were $6.8 million and $6.6 million in 2010 and 2009, respectively.