Re/insurers seem to be coming to terms with reserving for their long-term liabilities says Ronald Gift Mullins, while questioning whether it can ever be an exact science
The sins of under reserving by property/casualty (P/C) re/insurers for business written in the last few years of the 20th century seem to be diminishing as the companies' profits have strengthened since 2002.
But continuing to harass some re/insurers into the 21st century are legacy claims, some a half-century old, from asbestos, environmental and other long-tail casualty losses.
The dominant factor in overcoming the drag of these deep-rooted claims is the continuing profitability of the reinsurance industry and indications are that price reductions in early 2005 have been kept to manageable levels.
According to a report by Standard & Poor's (S&P), "Early evidence from the January 1, 2005, treaty renewals is that while reinsurance premium rates are still softening, the declines remain orderly - generally in the region of 5% to 15% for loss-free accounts. For loss-affected accounts and Caribbean risks, generally rate rises of up to 35% have been achieved, but this is only a small subset of the industry."
In a report issued in late 2004, Moody's said, "Positive conditions have enabled both reinsurers and their primary cedants to strengthen reserve levels and to bolster balance sheets."
But the rating firm warned that in spite of profitable years in 2003 and 2004, "deficiencies in core reserves for business written from 1997 to 2001, as well as funding levels for asbestos liabilities, will both remain a concern," but said the magnitude of charges for most re/insurers is likely to be less than those in the recent past.
"While asbestos-related reserve additions during 2002 and 2003 were significant, we anticipate further increases absent comprehensive asbestos reform.
The US insurance industry has recognized only $50bn of net asbestos liabilities compared to Tillinghast's estimate of $60bn ultimately," said Jenni Biggs, principal and co-leader of Tillinghast's asbestos practice.
Through 2003, the P/C re/insurance industry made significant progress in addressing its reserve deficiencies, according to a study by Conning Research & Consulting. Yet competition accelerated in the second half of 2004, and there were indications of reductions in reserve strengthening and premium rate declines in the face of loss growth. "When rates do not keep pace with loss growth," the report said, "there is certainly reason for concern about the industry's loss reserve position going forward."
Uncertainty continues as to whether reinsurers are fully recognising their exposures, according to report issued in mid 2004 by AM Best, especially given the apparent disconnect with the generally higher levels of reserving among US primary insurance companies.
"It would be very optimistic to assume," the report said, "that no further bad news will emerge from the reinsurance market over the coming months."
Confirming this speculation, GE Insurance Solutions increased its reserves for the fourth quarter 2004 by $734m - the increase was for asbestos and environmental liability, workers' compensation, directors' & officers' liability and auto liability, among other losses. During 2004, the company added $1.15bn to its reserves for prior years business.
Ace took a $298m charge in the 2004 fourth quarter for increased reserves for asbestos and other environmental claims, adding to its $3.74bn of reserves as of the end of September 2004. In January 2003, it added $2.2bn to its reserves for asbestos-related claims. Much of this was offset by reinsurance.
St Paul Travelers Cos Inc increased its asbestos and environmental liability reserves by $1.01bn for the fourth quarter, 2004, following a $228m charge against its fourth quarter earnings to boost reserves for medical malpractice business that is now in run-off. Earlier in 2004, the company had total pre-tax reserve adjustments of $1.59bn. The company said that this largely reflects the process of conforming the accounting and actuarial methods of the St Paul Cos Inc to those of the Travelers Property Casualty Corp.
Reserving a complex process
Generally, reinsurers deal with fairly complicated structures, annual aggregate deductibles, computation provisions, and are usually dependent on cedants for accurate data all of which make the job of estimating reserves for reinsurers a more complex process than for primary insurers.
Reserving in the years to come may depend greatly on the degree of competition among companies seeking to sustain growth in a softening rate environment which could result in declines in premium rates, moderating policy conditions/terms resulting in less profits which may slow or even reverse trends of reserve strengthening.
A study by AM Best found that since the beginning of the 21st century, the US P/C insurance industry has incurred ever-increasing asbestos and environmental losses, principally for its asbestos liabilities, culminating in 2003's pretax charge of nearly $7bn. Total asbestos and environmental losses incurred by the industry since 1999 have totaled more than $23bn, of which $22bn was for asbestos losses alone. As a result, AM Best's year-end 2003 estimate of unfunded asbestos and environmental liabilities for the US property/casualty industry is $14bn for asbestos and $24bn for environmental liability, for a total funding shortfall of $38bn.
Fitch Ratings estimates the US property/casualty insurance industry has a reserve deficiency of between $43.5bn and $61.5bn at year-end 2003, equalling between 12% and 17% of reported surplus. The company believes the reduction in the industry's loss reserve deficiency estimate is a function of significant adverse reserve development from prior underwriting periods reported by industry participants in recent years, as well as indications that reserves for the most recent accident year have been reported more conservatively.
"It is our experience," says James Auden, senior director, Fitch, "that companies and actuaries are not good in predicting a shift in a loss trend, either positive or negative."
Laline Carvalho, director, financial services ratings group, S&P, believes, "It is the US rather than the rest of the world, it is safe to say, where reserving is most important.
"Areas such as pollution/environmental issues and asbestos have been contributing to reserve inadequacy, in addition to under-pricing of business that was written in the last decade of the 20th century. Generally though, over the past few years, when we have seen reinsurers boosting reserves by a large amount, it has been across the board."
She says pricing and terms and conditions have improved within the last two years, but sees pricing already starting to decline, yet still she thinks "there is in most lines of business, room for reasonable profitability, compared to the late 1990s. This will help improve reserves in the years of '05 and '06."
Reserving is hardest for asbestos-related claims, says Stephan Christiansen, senior vice president and director of research, Conning. "Excess workers' comp. is a problem, but it can be more accurately predicted by examining trends of medical cost," he adds.
"New asbestos claims as much as anything reflect insureds suddenly being exposed to types of claims from sources that were never considered covered when the policies were issued.
"Although we believe there has been significant improvement in the industry's reserve position in the past few years," Mr Christiansen continues, "we do not believe it has eliminated the need for additional reserve strengthening.
Yet, the current focus on growth may be an indication that the industry is comfortable with its reserve position. This may be as good as it gets."
Fitch's Mr Auden believes "generally there are reserve deficiencies in reinsurance as there are in primary insurance. Claims from asbestos are a problem as are other long trail casualty lines. But, it is a problem that is diminishing for primary insurance companies as we see that most recent reserves are estimated more conservatively. Overall, reserving is positive in 2002 and 2003 compared with accident years 1998 to 2001, where reserving was developing unfavorably."
"Thanks to stronger pricing and resulting premium growth in the P/C industry, reserves have kept pace with losses and older years have been strengthened," says Geri Riley, analyst at Conning.
"The improvement in the reserve position for the property/casualty industry has been rapid and all-encompassing, leaving no line of business unaffected. Yet while there has been significant improvement, additional reserve strengthening is still needed."
Reserving - a range of estimates
Adding to or releasing reserves has historically been closely related to the profitability of the re/insurance industry. As companies advance in their fiscal years and determine if the year will produce an underwriting profit, there has been a tendency to use some of the profits to boost reserves. Vice versa, when profits are low, re/insurers look at reserves and determine that they are over funded and some of the "excess" is released to boost the bottom line.
"Reserving is always subject to a range of estimates," says Mr Christiansen.
"There is an inclination to be more conservative in some years and less conservative in others." He suggested that the Sarbanes-Oxley Act, which requires the chief executive officer to validate the company's financial results with his/her signature, alters the climate and affects the processes further down in the company of actuaries, auditors, underwriters and others.
"We feel reserves will be more closely estimated now," he says.
"It is difficult for us to see always what is happening in a company," says Ms Carvalho. "We do often times predict that there is some reserving deficiency, but our attempt is to come to a reasonable number."
S&P considers two kinds of difficulty that relate to the credibility of reserving actions of a reinsurer's management team. One, was it impossible for management to foresee a set of events such as the second wave of asbestos claims? If that is the main reason for the disparity in reserving, the rating company does not fault management for adjusting reserves.
It is a different story, however, if a company announces a major shift in loss costs or an increase in the severity of claims of business that matured a number of years ago, then the credibility of that company's management is called into question. For example, Ms Carvalho says that if a reinsurer is continuing now to add to reserves for business written in 1997 or 1999, it is difficult for management to justify getting it wrong.
"We have become a lot more aggressive in our press releases concerning reserving," Ms Carvalho says. "We often announce, 'Look, there is problem here.' In the end, we have to rely on management, the company knows better than anyone else what the true reserving picture is. We sometimes get it wrong. It's not a perfect world."
There has not been much room for building huge cushions for reserves for future losses or for past losses, she adds, because profits on current business have been eroded by current reserving actions.
Absolute reserving possible?
The cordial clash between rating agencies and re/insurers over the adequacy of reserves has been ongoing for as long as there was a claim more than a year old. The raters want to know as much as possible about the claims handling process of a company to accurately gauge its financial health.
The re/insurer desires to co-operate, but feels it is entitled to evaluate and assign its reserves according to its own formulas and requirements.
As far as estimating reserves, Fitch's Auden says he does not know if reinsurers could ever completely satisfy the information needs of rating companies. "We think we have enough information to get a really good handle on a company's reserving policies.
"It is good for us to know the processes they are using to figure out reserves and any disclosures that reflect the reality of reserving. We look at a company's business mix and we can tell if they are not reserving correctly, especially in long tail lines." But he cautions that rating companies can "get overwhelmed with too much information, not just in quantity, but how it is presented, meaning whether it is pertinent or useful."
There is a lot of information available, according to Ms Carvalho. "For the most part companies will provide data," she says. "We have access to confidential information, but the difficulty of determining accurate reserves is that we have to make certain actuarial assumptions of the data which may be subjective on our part."
S&P has its own internal models that are used as a starting point to evaluate a company's reserve adequacy. Within a re/insurer there are modelling programmes, but sometimes there is a disconnect between the actuarial division and the underwriting division, Ms Carvalho warns. "They are not always working with the same figures. We believe they are now tying to bridge the communication gap between the various divisions."
"How transparent can the process of reserving be made?" asks Mr Christiansen.
"The more you push for transparency, eventually it gets into propriety information and beyond what can be made public. Satisfying rating agencies can be a bottomless cup. They may be satisfied for a period of time, but technologies will change, new forms of exposures will emerge and rating agencies will have to respond by seeking more information."
- Ronald Gift Mullins is an insurance journalist based in New York City.