Unfavourable reserves could stimulate reinsurance demand

Third-quarter results for both Travelers and RLI cite unfavourable reserve developments as a contribution to weaker underwriting returns, underlining a potential need for greater reinsurance protection as reserves fall further at the same time that attritional catastrophe losses climb.

Both Travelers and RLI Corp have reported their third-quarter 2016 results, and both highlighted how unfavourable prior year reserve developments contributed to reduced profitability, while catastrophe losses have increased in 2016 when compared with previous years.

We’ve been discussing at Artemis for some time now how insurance and reinsurance market headwinds and resulting reduced profitability has seen some in the risk transfer landscape utilise a greater volume of reserves to boost returns and essentially mask true accident year underwriting profits.

Industry experts and analysts have warned that reserves could be running thin, and with catastrophe losses in 2016 increasing in the face of earthquakes, hurricanes, wildfires and a number of severe storms, the ability for re/insurers to maintain the levels of recent reserve releasing has been brought into question.

And as the results of RLI and Travelers show, less favourable prior year reserve developments at a time of heightened losses has contributed to declines in profitability, a trend that could see demand for reinsurance increase within the sector.

RLI states that a $1.4 million net decrease in underwriting income is a result of unfavourable development in prior years’ loss reserves, the first time this has happened in more than a decade.

But despite this, the firm’s combined ratio sits at 89% as it experienced more favourable conditions in the first two quarters of the year.

For Travelers the story is slightly different, with the firm reporting that net and operating income both declined in the quarter, largely due to lower net favourable prior year reserve development and higher losses from non-catastrophe weather-related losses.

At the same time, Travelers’ combined ratio deteriorated in the quarter to 92.9%, underlining the challenging landscape companies are operating in, and which is exacerbated by increased losses and unfavourable reserve developments.

Interestingly, Fitch Ratings has recently commented on the loss reserve adequacy of the property and casualty arena, saying that it expects overall reserve development to remain favourable in 2016 and 2017.

“The P/C industry reported favorable prior-period loss reserve development for 10 consecutive calendar years in 2015. This performance is a testament to more conservative reserving practices and indicates balance sheet quality,” said Fitch.

Profitability in the sector is expected to remain compressed for the near future and with reserves potentially deteriorating further it could result in an increased demand for reinsurance protection to reduce volatility.

At the same time, with catastrophe losses increasing when compared with more recent years, reinsurers could also see their reserves deteriorate as well, which in turn could lead to greater retrocessional demand.

Should losses in the final months of the year hike it will be interesting to see how reserve developments impact full-year and Q4 results for insurers and reinsurers. Furthermore, over the coming weeks the majority of companies will release their Q3 results, and it’s very possible that Travelers and RLI aren’t the only ones citing unfavorable reserve developments as a driving force behind lower profitability.

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