Property-casualty insurers are dropping their reserves in the face of losses and declining rates in an effort to keep their return on equity high, a financial analyst said.
Morgan Stanley analyst William Wilt wrote that p-c insurers' loss reserve redundancy (capital reserved above expected losses) fell 4 percent, or $1 billion, to more than $16 billion.
"We appear to have passed the reserving high-water mark," he wrote, noting that more than three years of rate decreases plus accelerating medical inflation "could drain redundancies rather quickly going forward."
He said the estimate is "highly skewed by workers' compensation." In Mr. Wilt's estimation, a more careful analysis of inflationary pressures could lead to downward revisions in the "estimated reserve cushion."
Private passenger witnessed a dramatic drop of more than $3 billion from last year, he continued, to a forecast deficit of $1 billion because of accelerating cost trends.
"Our estimate of the reserve redundancy on accident-year 2007 was almost one-half the comparable estimate on 2006, suggesting insurers are working harder to maintain the elevated ROEs [returns on equities] of recent years," he said.
Reserves padded operating earnings by 14 percent in 2007 for companies followed by Morgan Stanley, he said. If those numbers increase, it could be an indication companies are draining reserves faster than anticipated, he observed.
Mr. Wilt said these developments mean the soft market cycle turn could happen quicker than previously expected, a benefit to investors.
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