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There is a real risk that Casualty reserves for business written during 2015 will run off at a loss in the future.
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The strength of Casualty claims reserves set for business written during 2015 is 3% weaker than prior years of underwriting
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London market (re)insurers are counter-intuitively assuming that new Casualty business written during 2015 is, in aggregate, 2% more profitable than renewed business.
This review highlights the adequacy of reserves on Casualty business as an area in which the London (re)insurance market should focus its future attention. PwC’s view is that whilst some margins still exist on Casualty reserves held on earlier underwriting years, no margin exists in Casualty reserves held for the 2015 year at a market level. The reserves on the 2015 year were, on average, 3% weaker than for business written in earlier underwriting years. Given the uncertainties involved, there is a real risk that reserves on the 2015 year will run off at a loss in the future.
The apparent change in reserving strength for business written during 2015 may have been influenced by aggressive pricing assumptions and insufficient feedback from pricing to the reserving exercises conducted. Actual premium rate reductions for renewed business have been materially larger than expected during 2015 but some London market (re)insurers continue to make use of business plan assumptions for reserving.
PwC's analysis indicates that London market (re)insurers assume that new Casualty business is, in aggregate, 2% more profitable than renewed business. However, this is out of line with PwC’s expectations, given that most of these risks are not new to the market and are often won competitively or lapsed by competitors, due to poor performance.
London market (re)insurers have, for many years, benefitted from reserve releases from prior years leading to accounting profits.
The Lloyd’s market accounts indicate that a 2015 accident year combined ratio of 104.5% was supported by reserve releases to deliver a 100% combined ratio for the Casualty market. This same situation will not, however, continue if the reserves held for the 2015 year are not as strong at those held in similar situations historically. There is, of course, also the risk of adverse run-offs emerging in the future if experience does not match the assumptions made in current reserving analyses.
The risk of under-reserving is heightened by the potential for London market (re)insurers to under-estimate future claims inflation owing to relatively low levels of claims inflation in recent years, in part, driven by weak economic growth.
Jerome Kirk, London Market actuarial leader at PwC, said: “A heavy reliance on reserve releases, fuelled by favourable claims experience, has become a feature of Lloyd’s and the London Market’s recent financial results.
“History has shown that the adequacy of reserves for Casualty business has always posed a risk to the London Market. Our exercise confirms that Casualty reserves on the most recent underwriting year are more vulnerable to adverse run-offs in the future than they have been in the recent past - particularly in a market segment that is only breaking even.
“For me, the most significant concern is the view being taken as to the profitability on new Casualty business, compared to the assumptions being made on renewed business. As we approach business planning season, firms should consider taking action to ensure that they are not overly exposed to the significant risks that the rating environment brings to reserves, capital and earnings.”
Harjit Saini, London Market director who led PwC's review, concluded: “Many diversified London market (re)insurers have increased their exposures to Casualty business over the past year as pressure on rates has intensified across other classes.
“Some of the information supporting underwriting is however, subject to question. For example, new business for Employers Liability and Professional Indemnity risks are assumed to have market average loss ratios which are over 5% lower than for renewals.
“This is particularly relevant against the backdrop of premium reductions throughout 2015 across Casualty classes that are in excess of the reductions assumed within initial business plans. The importance of robust price monitoring, especially in light of the increasing use of delegated underwriting, has never been more important.”
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