The US insurer is in crisis mode following its much-larger-than-expected $365m reserve increase and subsequent downgrade from the A range. While the troubles of a relatively small player will not have any knock-on effects on the wider market, observers such as rating agencies and equity analysts are entitled to wonder if this is the start of a trend.
Tower appears to have overreached, making acquisitions at prices that did not allow for much reserve creep. I suspect, though, that this is a signal that the remarkably long period of reserve redundancies that the industry has enjoyed is soon to end. This is being felt now by a few outliers but it can’t be long before the larger insurers’ reserving cushion deteriorates.
Bob Farnam, senior vice-president at Keefe, Bruyette & Woods (KBW), told Reactions in October: “We’ve been expecting the reserve development to deteriorate for the industry overall. It’s actually been favourable for a lot longer than we expected but we can’t expect that to last forever.”
Some may question what the big deal is, given that the US property/casualty industry appears to be enjoying a buoyant period. Improved pricing coupled with a boost to exposures from the slowly improving economy and disciplined underwriting produced a profit for the industry through the first six months of 2013, according to a recent AM Best report.
The rating agency noted that this year’s first half was the first time the industry has been profitable through June 30 since 2007. However, it is important to note the combined ratio improved by four points because of favourable reserve development for prior accident years, compared to 2.3 points in 2012. Insurers will soon no longer be able to rely on reserve releases to prop up results.
AM Best took the chance to express its concern with the industry’s loss-reserve position. This concern is particularly for commercial lines given the extended soft-market cycle, which it said had eroded pricing adequacy during those prior years while reducing the available reserves.
“In light of the level of favourable development recognised on recent accident years, the available cushion of reserve redundancies has declined and may not provide the same support to future calendar-year results,” AM Best warned.
Fellow rating agency Moody’s recently noted that US property/casualty insurers released $9bn of reserves during the first half of 2013, largely from big personal lines carriers. It believes the industry’s reserve position will remain “moderately redundant” at the end of 2013. This is based on rate firming, benign loss cost trends, enhanced underwriting standards and Moody’s estimate of $7bn to $11bn core reserve redundancy at year-end 2012.
“Given the rise in premium rates over the past three years relative to loss trends, we also expect modestly redundant accident year reserves in 2013 for standard commercial liability lines,” said Moody’s analyst Jasper Cooper. “2012 accident year reserve positions are breakeven to slightly deficient, an improvement from the deficiencies in 2010 and 2011.”
Commercial insurers will release reserves more slowly than personal insurers as redundancies for older accident years diminish, according to Moody’s. Most recent reserve releases come from other short tail lines, personal lines, reinsurance and medical malpractice, whereas in 2008 most releases were in commercial lines.
The world’s top 25 US property/casualty insurers display a wide range of reserve strength, with some having large redundancies while others have moderate deficiencies, Moody’s said.
In addition, Standard & Poor’s expressed its concern about companies prematurely releasing reverses from 2009 to 2012 because the rating agency says the pricing on this business is softer than the 2002 to 2008 period (see page 24).
All of this means that insurers and reinsurers have little room for error, with no reserve redundancies to rely on and little joy from investment income. Rating agencies have shown themselves quick to downgrade firms that have run into reserving problems.
The early 2000s were marked by a spate of downgrades as insurers and reinsurers propped up reserves from the cut-throat late-1990s long-tail business. It seems unlikely that firms will have reserving problems of that magnitude this time around, but 2014 looks like a year when the worse-run companies will start feeling the heat.
The lack of a reserving cushion should only serve to resolve discipline.
PartnerRe Global’s CEO Emmanuel Clarke told Reactions in Monte Carlo in September: “In any soft market the positive reserves developments will start drying up at some stage. We have seen this in the second quarter of this year. Over the next couple of years we will see some draining out.”
The reliance on reserves has caused a lag in the reporting of financial results that are benefiting from the tail of run-off business in positive years and investment income benefiting from yields two to three years ago.
“It’s clear this decade will be very different to what the last decade has been,” says Clarke. “I don’t think the industry has reflected the reliance on reserves by reinsurers. However, the current pricing and investment conditions are challenging. It’s a lot more challenging than it appears to be.”