By KATIE KUEHNER-HEBERT, who writes about the financial services industry
In one corner, property/casualty insurance industry giants that think they have enough capital to pay claims have reduced reserves.
From June 2009 to June this year, for instance, reserves at Hartford, Conn.-based Travelers Cos. Inc. fell 1.7 percent, to $38.75 billion. At competitor The Hartford Financial Service Group Inc., managers have trimmed reserves by less than 1 percent, to $17.72 billion.
To the north, at Boston-based Liberty Mutual Group, managers have pared reserves by 1 percent, to $31.99 billion. In the Midwest, Chicago-based CNA Financial Corp. cut reserves by 1.2 percent to $20.22 billion.
Nearby, in the Chicago suburb of Schaumburg, Ill., home to Zurich Financial Services' North America Group, managers have depleted the company's reserves by 1.8 percent, to $14.23 billion.
On the West Coast, insurance managers at the State Compensation Insurance Fund of California have been more aggressive, slicing reserves by 4.2 percent to $15.4 billion in the 12-month period ending in June.
The overall reduction of reserves may be small in percentage terms, but it translates into hundreds of millions of dollars.
"Releasing reserves is considered to be redundant above and beyond what they need, even if there are major catastrophes," said Bob Hartwig, president of the Insurance Information Institute. "No insurer, at least intentionally, releases at a level that would not be considered prudent--at least in theory."
Dipping into reserves means management doesn't think they are going to need the money. It also means carriers will have less in the bank in 2011 if they get hit with a large claims payout.
"There's going to be less of a cushion for any kind of catastrophic losses that could occur," said Ken Crerar, president of the Council of Insurance Agents & Brokers (CIAB), which represents large commercial insurance brokers.
In another corner, formidable industry equals are doing the opposite, building reserves.
New York City-based American International Group Inc. boosted reserves 6.7 percent to $52.04 billion from June 2009 to June this year. In Omaha, Neb., Berkshire Hathaway Inc., owned by iconic investor Warren Buffett, increased reserves by 2.5 percent, to $33 billion.
Chubb Group of Insurance Cos., the Warren, N.J.-based carrier, increased reserves by 2.2 percent to $17.267 billion over the 12-month period.
At FM Global, the Johnston, R.I.-based, engineering-heavy, mutual property underwriter, management turned up the Bunsen burner, boosting reserves by a whopping 21.2 percent, to $2.65 billion.
What is going on? Why are some carriers depleting reserves at the same time that competitors are increasing them?
Are the financial moves by the industry's best and brightest foolhardy or prudent given the soft pricing market and anemic investment returns? Or are managers making better use of capital? Have company managers miscalculated future claims costs? Or have models and company-paid actuaries hit their mark?
Marie Ali, a spokeswoman for Chartis, AIG's property/casualty business unit, said that reserves increases represent 3.6 percent of the company's total carried loss reserves of $63.2 billion at the end of last year, and are primarily related to excess casualty and excess workers' comp lines for accident years 2002 and prior.
FM Global has different reserves practices than most property/casualty insurers, said Jeff Beauman, FM Global's vice president of all-risk underwriting, in an e-mail to Risk & Insurance®.
FM Global, he wrote, keeps higher reserves to cover discontinued lines of business and to be able to pay claims quickly.
"We believe risk managers are looking for price stability from their property insurer, and it is our job to provide that stability," Beauman wrote.
Jim Neary, the State Compensation Insurance Fund's executive vice president and actuarial/chief adviser, said the risk managers needn't worry about the fund shaving its reserves by 4.2 percent.
Worker's comp reform in the Golden State several years ago has led to fewer claims and therefore fewer payouts, so there's no reason to hold as much cash in reserve.
"This reduction in costs allowed carriers to release reserves in subsequent periods," Neary wrote in an e-mail to Risk & Insurance®. "Unfortunately, the reserves releases may mask the next upward turn in loss costs.What's critical for the long-term stability of the industry is that we continually reassess what's needed and make adjustments accordingly."
At Liberty Mutual, future claims costs justify a trimming of reserves, a company spokesman said.
"Liberty Mutual sets and releases reserves based on the actual emergence of the claims for which the reserves were established, and our view of future claims costs," Richard Angevine said.
Despite softening rates, the U.S. property/casualty industry posted its fourth consecutive year of favorable reserves development in 2009, according to a Sept. 13 report by A.M. Best & Co.; carriers clearly feel confident they can safely draw down on their reserves.
A new report issued by Standard & Poor's has property/casualty insurers paring reserves by $1 billion and $4 billion, respectively in 2006 and 2007, before adding $1 billion in 2008.
A slow economy, smaller insured volumes, lower claims frequency, smaller investment returns ? it can mean less pressure to dip into a reserve fund to pay claims.
Across the entire property/casualty spectrum, policyholders' surplus, the value of an insurer's assets minus its liabilities, rose 3.7 percent to $530.5 billion in the first six months of 2010, according to Insurance Services Office Inc. (ISO), a provider of underwriting data and regulatory services.
Remove the $13.7 billion of asbestos and environmental deficiency, and another $22.5 billion of statutory discount, and the industry's core undiscounted reserves were believed to be redundant by $1.9 billion at the end 2009, according to A.M. Best & Co.
So do carriers need all that cash in the reserve vault?
For the moment there are no "glaring" indications that carriers are underreserved despite the reserves releases, said Michael R. Murray, ISO's assistant vice president for financial analysis.
"Because of the Great Recession we're just now emerging from, inflation has been slower than a lot of people might have expected when insurers set their loss reserves and claims frequency may have been lower," Murray said.
"If insurers had too much in the bank before they reduced reserves, then reserves releases may have just taken loss reserves down to more appropriate levels."
Reasons for reserves releases vary depending on the line of business from one particular carrier to the next, A.M. Best analyst Edward Keane said.
Carriers writing medical professional liability policies, for example, have been able to release reserves because of price increases that began in 2003 with tort reform.
Other insurers prematurely release reserves pertaining to more recent accident years to boost current-year underwriting results, Keane said.
"A number of insurers continue to be too optimistic about loss trends and are prematurely releasing loss reserves," Keane said. "This leaves open the potential for adverse development on these accident years and reduced profitability in future calendar years."
Inflation, as it always does, could mean big trouble for insurers with long-tail exposures, he said, leading to inadequate reserves over the long term, with claims costs exceeding pricing and reserving assumptions.
An August report by investment broker and bank Keefe, Bruyette and Woods echoed A.M. Best's predictions for a slowing of reserves releases.
"It always make sense to release reserves in a prudent manner, in a way that won't jeopardize the company at some point in the future," Hartwig said. "But at some point, releases will result in a deterioration in current calendar year results. These monies go directly to the bottom line, so in some sense, that is one of the profit engines that many insurers have today."
Eventually, carriers won't be able to do that any longer, pressure builds on earnings and that ultimately increases the pressure for carriers to raise rates, Hartwig said.
THE MARKET CONNECTION
From the perspective of risk managers, the trend among some carriers of depleting reserves puts more pressure on eventual rate increases, Crerar said.
"As capital is reduced to support those losses, carriers will have to rebuild capital in a couple of ways to ensure profitability, one of which is to raise prices," he said.
Unabated softness in the marketplace, expected to continue in 2011, will make it difficult for carriers to raise rates, and investment returns likely will remain mediocre.
Renewal rates on average declined by 5.2 percent in the third quarter, following a 6.4 percent decrease in the second quarter, according to the CIAB's third quarter Commercial Property/Casualty Market Index Survey. The survey also showed no immediate signs that the market is turning, Crerar said.
Astute risk managers are anticipating the eventual end of the soft market and are likely evaluating ways to moderate increased rates by raising deductibles or considering alternative-risk mechanisms such as risk retention groups or captives, Crerar said.
Bill Zachry, vice president of risk management at Safeway Inc., said that, when the market does harden, the extent to which premiums increase will depend on whether there is additional surplus flowing into the market.
Higher investment returns would delay the need for price increases in the marketplace, he said, and the question then becomes whether multiyear deals will be available for buyers, and if so, at what rates.
"If you can get multiyear deals, you're putting yourself in a good situation, and because of the long-term relationship, both sides have the ability to budget and manage the cash and expected premium costs," Zachry said.
To be sure, the amount of reserves by commercial insurance line varies, and that affects individual carriers' exposures, according to A.M. Best's report. Reserves available for medical-malpractice liability lines, for instance, are estimated to be $4.4 billion in excess of liabilities, Keane said.
"If the company writes other lines of business that have deficient reserves, then this excess can be reallocated to cover shortfalls in those other lines," he said.
The surplus can then be used to expand operations, purchase other companies, pay dividends or buy back shares, Keane added.
Reserves releases have been mostly in casualty lines like medical malpractice, Hartwig said.
"The problem begins to arise later on if inflation begins to tick up and claims cost more than anticipated; if the tort environment deteriorates and lawsuits become more costly; if medical care costs increase and workers' compensation claims increase above and beyond what has been anticipated," he said.
In contrast, the workers' comp line had a reserves deficiency of $18.3 billion at the end of 2009. The $18.3 billion deficiency includes $16.5 billion of discounts, A.M. Best's report said.
The other liability lines, including products liability, collectively had a deficiency of $4.7 billion, which includes $1.2 billion of discount--which implies an estimated $3.4 billion deficiency in undiscounted core reserves, according to the report.
While there is no direct correlation between insurers' investment portfolio performance and the decision by insurers to use investment gains to augment reserves, anemic interest rates make for low investment returns.
"Insurers are generally conservative investors," Crerar said. "In this low interest rate environment, the returns on those investments are not as high as in other periods.
"Insurers have had some good claims years and have been able to build up what are called redundant reserves--reserves they won't need for claims," Crerar said. "They have been releasing some of these reserves, which gives them room to compete on price.When these redundant reserves are depleted, insurers may be forced to raise rates because the cushion is no longer there."
Insurers' net investment gains in the first half of 2010 more than doubled, to $25.8 billion, from the first half of 2009, according to ISO data.
However, insurers' releases of loss and loss-adjustment expense reserves rose by 24 percent, to $8.8 billion over the same period, said Murray, the ISO assistant vice president.
December 1, 2010
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