London market casualty reserves vulnerable to adverse run-offs: PwC

With adequate profits on investment and underwriting sides of the balance sheet increasingly hard to come by for insurers and reinsurers, reserve releases have helped to bolster returns. However, casualty reserves in the Lloyd’s and London market are vulnerable to adverse run-offs in the future, according to PwC.

Insurers and reinsurers in the specialist Lloyd’s of London marketplace have relied on prior year reserve releases to boost returns for some time.

However, a recent market review by PwC highlights that apparent change in the reserving strength for casualty business written during 2015, suggests that in the future re/insurers might not be able to rely on reserves to strengthen financial results as they have in the past.

“A heavy reliance on reserve releases, fuelled by favourable claims experience, has become a feature of the Lloyd’s and London market’s recent financial results.

“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,” said Jerome Kirk, London Market actuarial leader at PwC.

PwC explains that despite some margins still existing on casualty reserves held under previous years, for 2015 no such margin exists at a market level, which implies there’s a real and dangerous risk that reserves will “run off at a loss in the future.”

On average, the reserves on the 2015 underwriting year were 3% weaker than for business written in previous years, says PwC, which was likely influenced by aggressive pricing assumptions and inadequate feedback from pricing to reserving.

According to the Lloyd’s market accounts, the 2015 accident year combined ratio of 104.5% was helped by reserve releases, that saw it deliver a 100% combined ratio for the casualty space.

However, with reserves held for the 2015 underwriting year failing to be as strong as previous years, Lloyd’s market participants could find themselves unable to rely on casualty reserves in the same way, resulting in a worse combined ratio and ultimately lower profitability.

“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,” said London Market Director, Harjit Saini, who also led the PwC review on casualty reserves.

The flood of alternative reinsurance capital that continues to expand and take a larger share of the overall reinsurance market pie has, for now, been largely focused on property catastrophe lines, owing to advanced modelling and easier market entry.

As a result, some insurers and reinsurers have pulled back on the highly competitive property cat space that has experienced the steepest rate declines in recent times, and looked to put capacity to work in less competitive, and potentially more profitable lines, such as casualty.

Redeploying capacity into different, more profitable business lines certainly isn’t anything new, and if done with discipline and managed well is a solid way to navigate testing market times.

However, with reserves seemingly weakening when compared with previous underwriting years, those in the Lloyd’s market with a high exposure to casualty business could find themselves in a difficult situation in the future.

“For me, the most significant concern is the view being taken that as to the profitability of new casualty business, compared to the assumptions being made on renewed business,” said Kirk.

Analysis from PwC reveals that London market re/insurance companies view new casualty business, in aggregate, as 2% more profitable than renewed business.

But PwC disagrees as it feels that the majority of these risks aren’t exactly new business, owing to the fact that it’s often won competitively or “lapsed by competitors, due to poor performance.”

“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 earnings,” continued Kirk.

We’ve discussed numerous times during the softening reinsurance market cycle that reserves appear to be dwindling, and that aggressive reserve releasing across any business class at times of benign losses and lower returns could come back to hurt some in the future.

So while the warning from PwC might be nothing new to some in the space, it’s a reminder that even for the less pressured, and less competitive areas, such as casualty, reserve and underwriting discipline, and mitigation of overexposure will likely prove vital in making it out of the softening landscape intact.

“The importance of robust price monitoring, especially in light of the increasing use of delegated underwriting, has never been more important,” said Saini.