The global (re)insurance markets are still in the doldrums after years of soft market conditions. No wonder last year’s run of destructive natural catastrophes sparked talk of a market correction, for a short time at least.
Not everyone thinks property cat losses are the sole agent of change right now, however. Some analysts have turned their attention to underlying trends in the long tail casualty business.
A more complex sector than property cat, the casualty business cycle is influenced by myriad socio-economic changes, ranging from judicial decisions to interest rates and inflation.
But what’s caught some casualty watchers’ attention recently is that (re)insurers are not only releasing their reserves to mask poor underwriting results, they’re accelerating their releases in some lines.
“Broadly speaking, we are one of those observers saying that reserve releases are not sustainable and that reserves are being released faster than more recent accident year experience would dictate,” says George Harris Hughes, Partner at JLT Re. “There is also evidence to suggest that some of these reserve releases are coming from the most recent accident year  – which seems to be somewhat aggressive.”
JLT Re’s own view is based on proprietorial research it undertook in 2016 (and updated last year), which analysed reported calendar year reserve movements since 1998 for the top 30 global (re)insurance companies. Its view is supported by some investment analysts.
Keefe, Bruyette & Woods said in a recent note that one of the major drivers of higher-than-expected reserve releases was workers’ compensation and that calendar year 2017 releases equalled total cumulative releases from 2012-2016.
In its annual analysis of industry reserves, investment bank Morgan Stanley reported a year-on-year deterioration that left property and casualty industry reserves US$4.3 billion deficient in 2017.
Deficiencies in reserves
Deficiencies are now present in five of the top six reserve lines, including workers’ compensation, personal auto liability, other liability occurrence, other liability claims made, and commercial auto liability, Morgan Stanley added.
JLT Re’s US CEO, Ed Hochberg, agrees: “I’ve been predicting that reserves will start to go upside down for the past five years and I’ve been wrong! But I do believe that it will happen, even though calling actuarial trends is difficult,” he says.
“We are seeing the early signals of that weakening, for example, in commercial auto and financial lines.”
Equity research firm Dowling & Partners believes that reserve strength has been weakening since 2008 and that the industry is getting close to the end of the ‘cheating phase’ and moving nearer towards the ‘restoration phase’.
Harris Hughes also believes that the market cycle may have reached an inflection point. “Reserve releases have allowed (re)insurers to mask the true performance of their book and have allowed (re)insurers to overstate positive rate change to keep loss ratios within target,” he says.
“As reserves deplete, this is beginning to take its toll. At the moment, the impact isn’t sufficient but, assuming that this is a trend, then [casualty] rates will invariably start to creep up.”
Balance sheet risk
So, the changing reserves picture presages a new rating environment in the global casualty sector.
But it could have a more far-reaching effect and trigger a harder market across the property-casualty spectrum.
Morgan Stanley has pointed out that between 2010 and 2017 reserve releases accounted for around 20 per cent (US$73 billion) of industry operating earnings.
Without the buffer of reserves, the risks to earnings increase; in a worst-case scenario, if there are reserving charges, alarm bells start to ring in the boardroom over balance sheet risk.
Some insurers have already started to seek protection and turned their attention to purchasing adverse development covers (ADCs), a form of reinsurance that reduces balance sheet risk and also adds a tangible capital benefit.
“It makes sense because it is economical to buy ADCs and there are a variety of products on offer that can meet clients’ requirements,” Harris Hughes points out.
Cedants in Europe and the US all need to keep a weather eye on monetary policy, according to Stuart Shipperlee, Ratings and Credit Analyst at Litmus Analysis: “The elephant in the room may well prove to be inflation. The flip-side of ‘lower for longer’ interest rates is that inflation has been [low] too. In effect, (re)insurers have been getting reserve release contributions rather than investment income,” Shipperlee says.
“For the US, the ‘Trump boom’ may well be changing that. At the time of writing, 10-year treasuries are climbing as inflation expectations increase. To borrow from the Sage of Omaha: when inflation goes up we may well see who has been reserving naked.”
JLT Re’s Harris Hughes believes (re)insurers would all benefit from some self-analysis: “Everyone needs to ask themselves, do they really believe their loss ratio picks; are they achieving the rate changes they are booking and do they believe the reserves that are being set are realistic?”
Please contact George Harris Hughes on +44 (0)207 466 5247 or firstname.lastname@example.org