Commercial property/casualty carriers have been drawing down precious capital from reserve accounts, making them vulnerable to longer-tail claims that could haunt them for years to come.
The decline in loss reserves is such a threat to the industry that rating agencies may begin downgrading companies they feel have drained reserves to the point they have diluted the strength of their balance sheets.
“Prudent ongoing reserving is crucial to the ability of insurers to pay claims and make a profit,” said Michael Gross, a director at Standard & Poor’s, during a panel on P/C reserves. “Everyone must be on guard that loss reserve inadequacy could emerge as a possible ratings mover in the years ahead.”
According to S&P research, the amount of reserves released by commercial P/C carriers has more than doubled each of the past three years.
In 2008, commercial carriers released over $11 billion in loss reserves after draining $5.7 billion in 2007.
Loss reserves act as a buffer against liabilities that are not immediately claimed. They are especially important for business lines that have “longer tails,” or liabilities that can see claims emerge years or decades after the insured event.
Examples of long-tail commercial insurance lines include workmen’s compensation and product liability.
Commercial insurers have been releasing reserves aggressively over the past several years, making it possible the industry could be setting itself up for problems in the future, said Gross.
“Predicting future claims is key to profitability and financial strength,” Gross said. “The question for me is why are they emptying their tanks?”
Releasing reserves could be especially problematic since commercial P/C carriers have yet to feel the brunt of claims made on major issues, such as errors and omissions (E&O) and directors and officers (D&O) arising from the subprime crisis.
“If you look at 2007 and 2008 and subprime liability, estimates are that it could reach between $6 billion to $10 billion in claims,” said Michael Angelina, chief actuary for Endurance Specialty Holdings. “Now is not the time to release, especially since 2008 may already be under-reserved.”
During the earlier part of the decade, P/C commercial carriers released significant reserves that eventually led to a period of reserve deficiencies that caused carriers to raise additional capital.
Several factors created reserve deficiencies during the previous market cycle, including poor underwriting, excess use of reinsurance and overly broad terms and conditions in commercial policies, Angelina said.
After 2001 many P/C carriers — especially those that were taken by surprise by an uptick in asbestos claims — were able to rebuild reserves during the hard market by raising rates.
“They were lucky there was a hard market, so there was a significant [reserve] recognition,” said Raji Bhagavatula, a principal at Milliman Inc.
In this cycle P/C carriers may not have the ability to raise rates significantly, especially since the industry remains in a soft market.
And even though some carriers argue they are seeing prices starting to stabilize, it may not happen quickly enough to prevent reinsurers being forced to recognize reserve deficiencies.
“We should not be celebrating the decrease in rate decreases,” said Angelina. “That’s not a hard market.”
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