London Re/Insurance Market Faces Risk of Casualty Reserve Shortfall: PwC

May 25, 2016

There is a real risk that casualty reserves for business written in 2015 will run off at a loss in the future, according to PwC’s London re/insurance market review of reserve adequacy.

PwC pointed to the fact that the strength of the claims reserves being set for casualty business written during 2015 is 3 percent weaker than in prior years of underwriting,

“London market re/insurers are counter-intuitively assuming that new casualty business written during 2015 is, in aggregate, 2 percent more profitable than renewed business,” the review affirmed.

“However, this is out of line with PwC’s expectations, given that most of these risks are not new to the market and are often won competitively or lapsed by competitors, due to poor performance,” said PwC.

“The apparent change in reserving strength for business written during 2015 may have been influenced by aggressive pricing assumptions and insufficient feedback from pricing to the reserving exercises conducted,” the review explained.

Reserve Releases

“London market re/insurers have, for many years, benefited from reserve releases from prior years leading to accounting profits,” PwC said, pointing to the example of Lloyd’s where a 2015 accident year combined ratio of 104.5 percent for the casualty market was supported by reserve releases to deliver a 100 percent combined ratio.

“A heavy reliance on reserve releases, fueled by favorable claims experience, has become a feature of Lloyd’s and the London market’s recent financial results,” said Jerome Kirk, London Market actuarial leader at PwC.

“History has shown that the adequacy of reserves for casualty business has always posed a risk to the London market,” said Kirk. “Our exercise confirms that casualty reserves on the most recent underwriting year are more vulnerable to adverse run-offs in the future than they have been in the recent past — particularly in a market segment that is only breaking even.”

“For me, the most significant concern is the view being taken as to the profitability on new casualty business, compared to the assumptions being made on renewed business,” he said. “As we approach business planning season, firms should consider taking action to ensure that they are not overly exposed to the significant risks that the rating environment brings to reserves, capital and earnings.”

“The risk of under-reserving is heightened by the potential for London market re/insurers to under-estimate future claims inflation owing to relatively low levels of claims inflation in recent years, in part, driven by weak economic growth,” PwC continued in its reserving review.

“Many diversified London market re/insurers have increased their exposures to casualty business over the past year as pressure on rates has intensified across other classes,” said Harjit Saini, London Market director who led PwC’s review.

“Some of the information supporting underwriting is however, subject to question. For example, new business for employers’ liability and professional Indemnity risks are assumed to have market average loss ratios which are over 5 percent lower than for renewals,” Saini said.

“This is particularly relevant against the backdrop of premium reductions throughout 2015 across casualty classes that are in excess of the reductions assumed within initial business plans. The importance of robust price monitoring, especially in light of the increasing use of delegated underwriting, has never been more important.”

Source: PwC

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