Reserves for Losses and Loss Expenses

The table below provides a roll forward of reserves for losses and loss expenses for beginning and ending reserve balances:



($ in thousands)	2012			2011		2010
Gross reserves for losses and loss expenses, at beginning of year	$	3,144,924		2,830,058		2,745,799
Less: reinsurance recoverable on unpaid losses and loss expenses, at beginning of year	549,490			313,739		271,610
Net reserves for losses and loss expenses, at beginning of year	2,595,434			2,516,319		2,474,189
Incurred losses and loss expenses for claims occurring in the:
Current year	1,146,591			1,113,733		1,025,707
Prior years	(25,601		)	(38,746	)	(43,589	)
Total incurred losses and loss expenses	1,120,990			1,074,987		982,118
Paid losses and loss expenses for claims occurring in the:
Current year	424,496			440,786		378,650
Prior years	632,742			569,944		561,338
Total paid losses and loss expenses	1,057,238			1,010,730		939,988
Acquisition of MUSIC losses and loss expense reserves	—			14,858		—
Net reserves for losses and loss expenses, at end of year	2,659,186			2,595,434		2,516,319
Add: Reinsurance recoverable on unpaid losses and loss expenses, at end of year¹	1,409,755			549,490		313,739
Gross reserves for losses and loss expenses at end of year	$	4,068,941		3,144,924		2,830,058

¹Includes $44.0 million related to the acquisition of MUSIC at December 31, 2011.

The net losses and loss expense reserves increased by $63.8 million in 2012, $79.1 million in 2011, and $42.1 million in 2010. The losses and loss expense reserves are net of anticipated recoveries for salvage and subrogation claims, which amounted to $62.2 million for 2012, $67.6 million for 2011, and $55.0 million for 2010. The changes in the net losses and loss expense reserves were the result of elevated catastrophe losses in 2012, growth in exposures, anticipated loss trends, changes in reinsurance retentions, as well as normal reserve development inherent in the uncertainty in establishing reserves for losses and loss expenses. As additional information is collected in the loss settlement process, reserves are adjusted accordingly. These adjustments are reflected in the Consolidated Statements of Income in the period in which such adjustments are recognized. These changes could have a material impact on the results of operations of future periods when the adjustments are made.

In 2012 we experienced overall favorable loss development of approximately $26 million as compared to $39 million in 2011 and $44 million in 2010. The following table summarizes the prior year development by line of business:



Favorable/(Unfavorable) Prior Year Development
($ in millions)	2012			2011		2010
General Liability	$	(3	)	12		26
Commercial Automobile	9			13		28
Workers' Compensation	(2		)	(7	)	(22	)
Business Owners' Policies	9			11		3
Commercial Property	3			6		3
Homeowners	9			4		6
Personal Automobile	—			(1	)	(2	)
Other	1			1		2
Total	$	26		39		44

The 2012 prior year development of $26 million includes $18 million of casualty development and $8 million of property development. The property development was primarily related to the favorable non-catastrophe loss activity that occurred in the first quarter of 2012 mostly in the 2011 accident year. The casualty lines were driven by favorable development in the 2007 through 2009 accident years; partially offset by unfavorable development in accident year 2011. The favorable development was driven by lower than expected severities in all of the major casualty lines, which represents a consistent trend in recent years. The unfavorable development in accident year 2011 was driven by: (i) higher than expected severities in the workers compensation and general liability lines; and (ii) higher than expected frequencies in the commercial auto line. This was partially offset by continued favorable development in the homeowners liability line, due to lower expected severity for this year.

The 2011 prior year development of $39 million includes $30 million of casualty development and $9 million of property development. Overall, the prior year development was driven by accident years 2006, 2008, and 2009, partially offset by the 2010 accident year. The favorable development was driven by the following: (i) premises and operations coverages on our general liability line; (ii) lower frequencies in the commercial automobile line; and (iii) continued favorable reported loss emergence on the liability coverage in our business owners' policy line. The unfavorable development in accident year 2010 was driven by the following: (i) increased severities experienced in our workers compensation line; and (ii) products coverage on our general liability line.

The 2010 prior year favorable development of $44 million includes $39 million of casualty development and $5 million of property development. Overall, the prior year development was driven by accident years 2003 through 2006, partially offset by the 2008 accident year. The favorable development was driven by our premises and operations coverages in our general liability line. The unfavorable development in the 2008 accident year was driven by increases in average severity in our workers compensation line.

Reserves established for liability insurance include exposure to asbestos and environmental claims. These claims have arisen primarily from insured exposures in municipal government, small non-manufacturing commercial risk, and homeowners policies. The emergence of these claims is slow and highly unpredictable. There are significant uncertainties in estimating our exposure to environmental claims (for both case and IBNR reserves) resulting from lack of relevant historical data, the delayed and inconsistent reporting patterns associated with these claims, and uncertainty as to the number and identity of claimants and complex legal and coverage issues. Legal issues that arise in environmental cases include federal or state venue, choice of law, causation, admissibility of evidence, allocation of damages and contribution among joint defendants, successor and predecessor liability, and whether direct action against insurers can be maintained. Coverage issues that arise in environmental cases include: the interpretation and application of policy exclusions; the determination and calculation of policy limits; the determination of the ultimate amount of a loss; the extent to which a loss is covered by a policy, if at all; the obligation of an insurer to defend a claim; and the extent to which a party can prove the existence of coverage. Courts have reached different and sometimes inconsistent conclusions on these legal and coverage issues. We do not discount to present value that portion of our losses and loss expense reserves expected to be paid in future periods.

The following table details our losses and loss expense reserves for various asbestos and environmental claims:



	2012
($ in millions)	Gross		Net
Asbestos	$	9.2	7.8
Landfill sites	13.0		8.1
Leaking underground storage tanks	13.4		11.9
Total	$	35.6	27.8

Estimating IBNR reserves for asbestos and environmental claims is difficult because of the delayed and inconsistent reporting patterns associated with these claims. In addition, there are significant uncertainties associated with estimating critical assumptions, such as average clean-up costs, third-party costs, potentially responsible party shares, allocation of damages, litigation and coverage costs, and potential state and federal legislative changes. Normal historically based actuarial approaches cannot be applied to environmental claims because past loss history is not indicative of future potential environmental losses. In addition, while certain alternative models can be applied, such models can produce significantly different results with small changes in assumptions.

The following table provides a roll forward of gross and net environmental incurred losses and loss expenses and related reserves thereon:



	2012					2011				2010
($ in thousands)	Gross			Net		Gross		Net		Gross		Net
Asbestos
Reserves for losses and loss expenses at beginning of year	$	8,412		6,586		9,979		8,167		11,056		9,244
Incurred losses and loss expenses	1,696			2,000		2,014		2,000		(338	)	(338	)
Less: losses and loss expenses paid	(938		)	(795	)	(3,581	)	(3,581	)	(739	)	(739	)
Reserves for losses and loss expenses at the end of year	$	9,170		7,791		8,412		6,586		9,979		8,167

Environmental
Reserves for losses and loss expenses at beginning of year	$	27,600		21,330		33,630		27,599		35,864		28,803
Incurred losses and loss expenses	1,363			1,000		(4,285	)	(4,750	)	1,500		2,276
Less: losses and loss expenses paid	(2,558		)	(2,352	)	(1,745	)	(1,519	)	(3,734	)	(3,480	)
Reserves for losses and loss expenses at the end of year	$	26,405		19,978		27,600		21,330		33,630		27,599

Total Environmental Claims
Reserves for losses and loss expenses at beginning of year	$	36,012		27,916		43,609		35,766		46,920		38,047
Incurred losses and loss expenses	3,059			3,000		(2,271	)	(2,750	)	1,162		1,938
Less: losses and loss expenses paid	(3,496		)	(3,147	)	(5,326	)	(5,100	)	(4,473	)	(4,219	)
Reserves for losses and loss expenses at the end of year	$	35,575		27,769		36,012		27,916		43,609		35,766