Posted On: August 20, 2004, 6:13 pm CDT

Posted By: Matt

David:

I don't think you fairly look at what reserves are and how they affect an insurance company's ability to operate profitably over the long term. Failing to reserve results in situations like Reliance National, General Accident, Commercial Union, Kemper, Royal Sunalliance, Providence Washington etc.

Increasing reserves drains a carriers ability to accept more premiums or policy count/PIF. Reserves are not surplus/capacity. Reserves drain capacity. Draining surplus by shifting it to reserves hinders a carrier from writing more premiums/policies unless it is in a very hard market. Carriers need to maintain a certain written premium to surplus ratio. If the carrier's premiums are far above their surplus then their financial ratings are hammered. Then they can't raise capital through stock or bond offerings and are stuck in a downward spiral unless they can shed accounts and improve their profitability, but that is difficult depending on the loss/claim cost environment (medical expenses only seem to be going up - see problems in the work comp market). Seeing how the market is softening, having adequate reserve accounts are crucial to the long term stability of a carrier. In a soft market, with flat or decreasing premiums, it will be difficult to fund inadequate reserves - see Kemper, Reliance, etc.

Carriers are not in this investment environment - especially seeing how reserves have to be in bonds, or liquid assets (and both have horrible yields) - going to increase reserves unnecessarily. Also carriers increasing reserves usually have to raise additional capital - see what CNA and The Hartford had to do in 2003. With the return on equity being so poor for insurance companies I can't see how the financial markets will rush in to buy insurance stocks or bonds when everyone is forecasting a softening market with lower profits for P&C insurance companies. When carriers fool with reserves it is usually to underestimate them so that the written premiums to surplus ratio looks better and they can take in more premiums to invest or try to make an underwriting profit. When a market is softening like we are seeing here it is very difficult to increase reserves and grow your premium at the same time - unless it is a very large and well funded and well managed company (AIG, The Hartford and St Paul Travelers).

One last note - as an industry the top five carriers (State Farm, Zurich/Farmers, AIG, Allstate and St Paul Travelers) control about 20-25% of the total industry reserves. The remaining 2000+ companies have the remaining 75-80% of the reserves. How many more Reliance Nationals are we going to see - where the PA state insurance department is advising the Claimants for both First Party and Third Party losses that the state's total guaranty fund is not adequate to meet the minimum claim amounts it was supposedly funded for.