Fitch: Reserves Remain Adequate, But Recent Years Unlikely to Develop Redundantly

Looking forward, Fitch says it expects a continuation of loss-reserve stability due to the economic environment and steady loss-cost trends. Looking forward, Fitch says it expects a continuation of loss-reserve stability due to the economic environment and steady loss-cost trends.

NU Online News Service, Aug. 23, 1:45 p.m. EDT

U.S. property and casualty loss reserves remain within an adequate range as of year-end 2010, and the potential for large deficiencies emerging in the near-term is limited, according to a Fitch analysis.

But Fitch notes that while favorable reserve development trends have continued based on strong underwriting profitability from the previous hard market, that level of favorable reserve development “appears unsustainable.” Fitch says that “incurred losses for accident years 2008-2010 are less likely to develop redundantly over time as prior hard-market underwriting periods experienced.”

Still, Fitch says that the industry has benefited from stable loss trends, and while 2008-2010 experienced weaker underwriting performance, reserve experience in aggregate for the 2008 and 2009 underwriting periods “defied expectations” by developing favorably, at least so far.

Industry Reserves by Line of BusinessFitch says it estimates that loss reserves for the 10 most-recent accident years were redundant at year-end 2010 by $6 billion to $16 billion, which is moderately lower than Fitch’s year-end 2009 estimate.

The rating agency says it arrives at this estimate by using a reserve adequacy model that projects ultimate accident-year losses on a paid and case-incurred basis by business line for 2001-2010. Fitch says its analysis shows a reduction in the estimated redundancy for accident year 2003-2007, while the more recent soft-market accident years of 2008-2010 are “reserved more likely at adequate levels.”

The estimate for 2008-2010 is more optimistic than a recent Keefe, Bruyette & Woods analysis, which contends that accident years 2008-2010 show total deficiencies of $6.4 billion: $3.44 billion in 2008, $1.4 billion in 2009 and $1.54 billion in 2010.

Looking at individual lines, Fitch says, “The biggest change in reserve adequacy in recent years has taken place in the workers’ compensation lines, which currently looks deficient. Other segments that are estimated to be understated in aggregate are product liability--occurrence, and to a lesser degree, commercial multiperil.”

Medical malpractice--claims made and occurrence, as well as “other liability--occurrence” were shown to be the most redundant lines, according to Fitch. Private passenger auto liability was listed as slightly redundant, while homeowners' and commercial auto liability were adequate.

Separate from the accident-year losses, Fitch individually considers reserves for asbestos, environmental and other long-tail claims derived from accident years prior to 2000. Factoring in these figures, Fitch projects that the industry’s net loss and loss-adjustment expense reserves fell in a range of $10.2 billion redundant to $8.7 billion deficient as of year-end 2010. The results, Fitch says, are similar to 2009 estimates as the decline in accident-year redundancy is offset by a modest drop in estimated deficiency for various latent liability losses.

“Prior-period reserves have developed unfavorably in each of the last 10 years, averaging $5 billion annually for the industry,” Fitch says. The prior-period reserves are concentrated in workers’ comp, general liability occurrence, reinsurance--liability and product liability--occurrence.

Asbestos-related claims filings have stabilized compared to the early 2000s, Fitch says, but the rating agency notes that American International Group’s Chartis and Hartford Financial Services Group, Inc. recently increased asbestos reserves.

Fitch says environmental reserves “continue to shift lower for the industry as paid losses continue to outpace incurred losses.”

Looking forward, Fitch says it expects a continuation of loss-reserve stability due to the economic environment and steady loss-cost trends.

“Fitch continues to believe that the greatest threat to maintaining adequate loss reserves going forward is an unexpected shift in inflation/interest rates, or loss-cost factors that more-specifically influence insurance claims costs, such as medical costs, litigation settlements, or social inflation.”

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