Do Bad Reserves Kill P-C Insurers, Or Is Bad Management More To Blame?

“Guns dont kill people. People kill people.”

I was reminded of the slogan of an old advertising campaign put together by gun control opponents as I read through a bunch of e-mails about property-casualty insurance companies that I received recently.

The e-mails were actually part of a running conversation about a study by rating agency A.M. Best on property-casualty insurance company failures. While I am bound to maintain the confidentiality of authors and their specific remarks, the gist of their comments is relevant to anyone who cares about the fate of the p-c industry.

In the study that the e-mailers referred to, Oldwick, N.J.-based Best reported that 77 percent of the 30 failures in 2001, and 70 percent of another set of 30 failures in 2000 were caused by deficient loss reserves.

The thread of e-mails began with a handful of writers calling for an effort to wipe out such reserve-driven insolvencies.

These few brave souls suggested that when the National Association of Insurance Commissioners a decade ago started to require that opinions certifying the reasonableness of loss reserves be filed with insurer annual statements, there was an unspoken promise that the industry would, in time, be rid of such problems.

Now A.M. Best is reporting that reserve-related insolvencies have gone up, instead of down. Historically, the insolvency rate from insufficient reserves had ranged from 30-to-35 percent prior to 2000, Best reports.

Hold on, the next, bigger and more vocal group of e-mail writers responded.

Reserves dont kill companies. Fraudulent or incompetent leaders and bad underwriting decisions kill companies.

One writer even presented a precise definition of loss reserves, explaining that an accounting item to represent future cash flows is not capable, in the same way individuals are, to act to bring down a company.

Another creative e-mail writer opposed these views, suggesting that deficient reserves can indeed be a root of insolvency, pointing out that inadequate reserves produce overstated surplus, which in turn impairs management judgment and leads to bad underwriting decisions.

I tend not to be that creative.

And I would tend to agree that mismanagement is at the heart of most insolvencies. Its a difficult task to sort through the myriad of problems that put a company on the road to failure to pinpoint the primary cause–and A.M. Best might indeed have overstated the case when it reported that “deficient loss reserves” caused the majority of insolvencies in 2000 and 2001.

So what?

Suppose the A.M. Best assertion hadnt been quite so strong.

Instead of reporting that 23 out of 30 companies became insolvent in 2001 “due to deficient loss reserves,” lets suppose the report said the following: “The majority of the companies that failed–23 out of the 30–had deficient loss reserves when they failed.”

There. Does everyone feel better?

I dont. And neither should any chief financial officer, vice president, actuary, consultant or auditor who set, reviewed or signed off on the reserves of any of the 23 companies to which Best is referring.

It is quite likely that bad (or at least inattentive) people in management positions were behind many of those insolvencies.

And if you put a gun in an evil or careless persons hands, hell do bad things with it.

Even if we view reserves–or the procedures that gave rise to their inadequate levels–as only one weapon in the arsenal of causes that bring down companies, theres still an obvious problem that needs to be rectified.

Along with fraud, overstated assets, rapid growth, reinsurance failure, and catastrophes, loss reserving processes have a rightful place on Bests list of causes of p-c failures. Exactly where it ranks seems less relevant to the discussion.

NU Senior Editor Susanne Sclafane is a fellow of the Casualty Actuarial Society.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, August 12, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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Do Bad Reserves Kill P-C Insurers, Or Is Bad Management More To Blame?

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