NU Online News Service, July 25, 2:12 p.m.EDT

While property and casualty insurers have benefitted fromfavorable loss-reserve development in recent years, a Keefe,Bruyette & Woods (KBW) analysis contends that accident years2008 to 2010 are underreserved and that adverse development willresult in the future.

KBW says it expects accident years 2003 to 2007 to remainredundant. The firm also says that, according to its analysis,reserve adequacy varies by line, with medical-malpractice and otherliability lines appearing redundant while workers’ compensation,nonproportional assumed reinsurance and products liability appeardeficient.

KBW says it used both paid losses and case-incurred losses and anumber of reserving methods to generate its opinion on reserveadequacy. “These methods generate a range of reserve estimates, andwe average the most credible results to determine reserveadequacy,” KBW explains. Looking at reserve adequacy for 2001 to2010, KBW’s analysis finds that reserves are deficient by $2.7billion, or 0.5 percent as of year-end 2010.

The analysis shows deficiencies of $415 million and $286 millionfor accident years 2001 and 2002, respectively. Reserves forsubsequent accident years are redundant by $389 million (2003),$928 million (2004), $531 million (2005), $1.66 billion (2006) and$895 million (2007). According to the analysis, accident years 2008to 2010 show total deficiencies of $6.4 billion: $3.44 billion in2008, $1.4 billion in 2009 and $1.54 billion in 2010.

At year-end 2010, the lines showing the greatest reservedeficiencies for the 2001 to 2010 time period, according to KBW’sanalysis, are workers’ compensation, deficient by $2.33 billion;products liability—occurrence, deficient by $1.6 billion; andreinsurance—nonproportional assumed liability, deficient by $1.34billion.

KBW notes that reserve analysis “comes with the usual caveats,as results are typically subject to changes in policy terms andconditions, claims handling, reinsurance and business mix.”

The firm says it expects P&C insurers to see a drop-off inthe earnings benefit they receive from favorable reservedevelopment, “and we expect many companies will even need to takereserve charges in the next couple of years.

Given this expectation, KBW contends that solid underwritingresults will be critical for companies to achieve acceptablereturns, as weaker investment income is expected in the near term.KBW notes, though, that the market may be years away from seeing aturn toward a harder rate environment.

“Right or wrong,” KBW says, “many management teams believe theircompanies’ reserves are still redundant, and expectations forfurther favorable development may reduce the urgency to seeksubstantial rate increases now.”