P/C Insurers’ Loss Reserves Continue to Surprise Analysts

By Susanne Sclafane | December 27, 2012
finance chess

Analysts at two rating agencies, Fitch and Moody’s, believe property/casualty insurers’ prior-year loss reserve takedowns will continue to outpace reserve additions in 2013.

The analysts spoke about P/C industry reserving trends as they reviewed their year-end outlooks and 2013 forecasts with Insurance Journal recently.

“We think accident years 2003-2008 are the gift that keeps on giving,” said Jasper Cooper, associate analyst for Moody’s U.S. Insurance team. “We expect companies will continue to release reserves for those years in 2013,” he says, noting that the only deficiencies in evidence are slight, and relate to accident years 2010 and 2011.

In the aggregate, for all accident years, reserve releases will continue, albeit smaller in 2013, he said.

Moody’s believes that while reserve adequacy margins are lowest for workers’ compensation and commercial auto liability, the overall industry margin of redundancy is between 2-4 percent of carried core reserves at year-end 2011 (excluding asbestos and environmental).

Explaining the “gift” reference, Moody’s Senior Vice President Alan Murray described the surprise that analysts have felt as they looked at announcements of reserve takedowns at individual companies during each of the last three years, expecting the well to dry up for the industry in aggregate at each year end. “Sure enough, there still is a redundancy.”

“We didn’t expect [the industry reserve position] to be favorable this long, and I don’t think the industry expected it either. Obviously, that won’t go on forever, but it still is providing the industry a cushion.”

Like the Moody’s analysts, Fitch’s James Auden, a managing director, predicts favorable development when the books are closed on 2012. “We keep thinking it’s going to be done, but it continues to surprise.” The amount of favorable development will be a little below last year, “but still pretty significant,” he said.

Like Cooper, he highlighted accident years 2003-2007 as the ones that have proven to be most redundant. “For those really good years, the losses have largely paid out, he said, predicting less of a favorable impact going forward.

“For the more recent [accident] years, where the bulk of the industry reserves are, we don’t think they’re reserved as conservatively. So even if they do prove to be slightly redundant, it’s not going to lead to the same magnitude of favorable development going forward.”

“Inevitably it has to slow. We thought it would have by now,” Auden said.

At Conning, where an analysis of the industry loss reserve position as of year-end 2011 pointed to redundancy of approximately 2 percent of carried reserves for 2011, Managing Director Steve Webersen said the significant releases of recent years “suggest that the reserve cycle will reach an inflection point where releases give way to strengthening—possibly by 2014.”

Meyer Shields, a managing director of Equity Research for Stifel Nicolaus, broke from the group, anticipating that reserve strengthening will come in 2013.

Referencing a recent analysis by his firm, he notes that prior-period reserve releases, which have been improving reported calendar-year results in recent years, “are slowing down pretty dramatically” for the overwhelming majority of commercial lines of business.

“As that leg of the earnings stool falls away, we’re just left with particularly discouraging accident-year results,” he said, adding that slightly higher medical cost inflation will also hurt underwriting profits. “I’m not talking about skyrocketing numbers. It’s certainly within control, just worse than it had been,” he said, noting that the external catalyst of inflation, “in addition to normal cyclical factors translating into smaller reserve releases,” will push reserve development “to a worse, more adverse scenario.”

In general, he predicts reserve additions, not takedowns in 2013, but still offers a combined ratio forecast that two-to-three points lower than for 2012: 107 for 2012, and a 104-105 range for 2013.

“Rate increases that started last year and are now compounding themselves should start to improve accident-year numbers,” Shields said, noting that the expected improvement from pricing should outweigh deterioration in the reserve-development numbers.

Taking Fitch’s view of weaker reserve additions and sustained pricing momentum into account, Auden said Fitch is forecasting a breakeven industry combined ratio for 2013—an improvement from result in the 103-104 range for 2012.

 

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Latest Comments

  • January 2, 2013 at 6:13 pm
    An actuary says:
    This phenomenon is largely caused by changes in terms and conditions. The actuaries that estimate reserve needs are pretty good at estimating price changes and adjusting thei... read more
  • December 28, 2012 at 1:45 pm
    Dave says:
    Interesting that while many insurers are expected to use over-reserved losses in previous years to improve current earnings the 600 pound gorilla in the room still has to keep... read more
  • December 28, 2012 at 1:33 pm
    Retired UW says:
    The insurer's are still cookin' the books to improve balance sheets. If they were truthful about their WC and auto reserves, they'd all need government bail out funding.
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