16. 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 following table provides a reconciliation of the gross beginning and ending reserve for unpaid losses and loss adjustment expenses (results for Chaucer for the year ended December 31, 2011 reflect the period from July 1, 2011 to December 31, 2011).


FOR THE YEARS ENDED DECEMBER 31	2012			2011			2010
(in millions)
Gross loss and LAE reserves, beginning of year	$	5,760.3		$	3,277.7		$	3,153.9
Reinsurance recoverable on unpaid losses		1,931.8			1,115.5			1,060.2
Net loss and LAE reserves, beginning of year		3,828.5			2,162.2			2,093.7
Net incurred losses and LAE in respect of losses occurring in:
Current year		2,990.2			2,654.1			1,967.4
Prior years		(15.8	)		(103.3	)		(111.1	)
Total incurred losses and LAE		2,974.4			2,550.8			1,856.3
Net payments of losses and LAE in respect of losses occurring in:
Current year		1,317.6			1,482.4			1,078.7
Prior years		1,396.5			1,010.3			738.6
Total payments		2,714.1			2,492.7			1,817.3
Purchase of Chaucer, net of reinsurance recoverable on unpaid losses of $669.6		—			1,631.0			—
Purchase of Campania		—			—			29.5
Effect of foreign exchange rate changes		33.9			(22.8	)		—
Net reserve for losses and LAE, end of year		4,122.7			3,828.5			2,162.2
Reinsurance recoverable on unpaid losses		2,074.3			1,931.8			1,115.5
Gross reserve for losses and LAE, end of year	$	6,197.0		$	5,760.3		$	3,277.7

As part of an ongoing process, the reserves have been re-estimated for all prior accident years and were decreased by $15.8 million, $103.3 million and $111.1 million in 2012, 2011 and 2010, respectively. For the year ended December 31, 2012, and the six months ended December 31, 2011, these amounts include favorable loss and LAE reserve development of $72.6 million and $35.5 million, respectively for Chaucer. The Chaucer favorable development during the year ended December 31, 2012 was primarily the result of lower than expected losses in the energy line, primarily in the 2008 through 2011 accident years, marine and aviation lines, primarily in the 2007 through 2011 accident years, casualty lines, primarily in the 2010 and 2011 accident years, and the property lines, primarily in the 2009 through 2011 accident years. For Commercial and Personal Lines, the unfavorable loss and LAE development during the year ended December 31, 2012 was primarily the result of higher than expected losses within other commercial lines, primarily in the contract surety line due to the ongoing challenging macroeconomic environment for contractors, and to a lesser extent, the AIX program business, primarily related unexpected severity in commercial automobile liability, commercial multiple peril and general liability in a limited number of programs, and from higher than expected large losses within the commercial automobile line, primarily related to liability coverage in the 2011 accident year. In addition, the Company experienced higher than expected losses within the personal automobile line, primarily related to bodily injury severity in the 2010 and 2011 accident years, and higher than expected homeowners property losses from non-catastrophe weather related activity in the 2011 accident year. Partially offsetting the unfavorable development was lower than expected losses within the commercial multiple peril line, related to the 2008 through 2011 accident years.

The $103.3 million favorable loss and LAE reserve development during the year ended December 31, 2011 includes favorable loss and LAE reserve development of $35.5 million for Chaucer. The Chaucer favorable development was primarily the result of lower than expected losses in the energy, property and U.K. motor lines, primarily related to the 2009 and 2010 accident years. For Commercial and Personal Lines, the favorable loss and LAE reserve development during the year ended December 31, 2011 was primarily the result of lower than expected losses in the personal automobile line, primarily related to bodily injury coverage in the 2008 through 2010 accident years, the commercial multiple peril line related to the 2007 through 2010 accident years and lower than expected losses in the 2007 through 2010 accident years in the workers’ compensation line. In addition, within other commercial lines, unfavorable development in the professional liability and surety lines were partially offset by favorable development in the healthcare and other commercial property lines.

The $111.1 million favorable loss and LAE reserve development during the year ended December 31, 2010 is primarily the result of lower than expected losses in the personal automobile line across all coverages, primarily related to the 2009 accident year, and lower than expected losses in the workers’ compensation line, primarily related to the 2008 and 2009 accident years. In addition, lower than expected losses 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 the surety business, primarily related to the 2009 accident year. 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.

Loss and LAE reserves related to asbestos and environmental damage liability, primarily in other commercial lines, were $60.5 million, $59.8 million and $63.9 million as of December 31, 2012, 2011 and 2010, respectively. Ending loss and LAE reserves for all direct business written by the Company related to asbestos and environmental damage liability, included in the reserve for losses and LAE, were $9.8 million, $10.0 million and $10.1 million, net of reinsurance of $20.4 million, $18.7 million and $19.9 million as of December 31, 2012, 2011 and 2010, respectively. As a result of the Company’s 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 the Company’s total loss and LAE incurred experience. In addition, the Company has established gross loss and LAE reserves for its run-off voluntary assumed reinsurance pool business with asbestos and environmental damage liability of $30.3 million, $31.1 million and $33.9 million at December 31, 2012, 2011 and 2010, 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 it was a participant. Because of the inherent uncertainty regarding the types of claims in these pools, the Company cannot provide assurance that its 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 the Company’s results of operations for a particular quarterly or annual period or its financial position.