Insurance literature is replete with articles, analyses, studies and discussion documents related to industry loss and loss adjustment expense (L&LAE) reserves, the impact of L&LAE reserve adequacy on insurance pricing cycles as well as the correlation between inadequate L&LAE reserves and the failure rates of carriers. However, we found negligible justification for the terminology or analysis of “industry L&LAE reserves” and no rigorous discussion of the impact of underreserving L&LAE on the overstatement of reported income by solvent carriers.

Executive Summary

Analyses of property/casualty "industry" loss and loss expense reserves may not be meaningful in an industry where seven carriers account for one-fifth of the overall aggregate industry total and where reserves for three-quarters of the carriers taken together don't even add up to the total for the largest insurer, State Farm, says Joseph L. Petrelli, President of Demotech. In the first of a two-part series of articles, Petrelli reviews loss reserve concentrations. In part 2, he reviews the relationship between reserve development and financial strength ratings assigned by other rating agencies. For the complete report, download the entire whitepaper, "A Discussion of P/C Loss and Loss Adjustment Expense Reserve Studies."

In an effort to initiate thoughtful review and dialogue on these issues, Demotech undertook this study to investigate two questions:

Is the term “industry loss and loss adjustment expense reserves” a meaningful one? Has the relationship between underreporting of L&LAE and the resulting overreporting of income been thoroughly discussed? If not, why not?

A review of some of the relevant literature is set forth in our full whitepaper, “A Discussion of P/C Loss and Loss Adjustment Expense Reserve Studies.” In this part of our two-part article, we delve into the first question, saving investigation of the second for Part 2, “Underreserving, Balance Sheet Fundamentals Taking a Back Seat in Rating Agency Analyses.”

Concentration of L&LAE Reserves

Our analysis of the L&LAE reported and recorded by property and casualty (P/C) insurers focused on the 2,137 insurers reporting financial information to the NAIC that reported that their loss and loss adjustment expenses reserves at year-end 2013 were greater than zero. We excluded 559 carriers with reported L&LAE of zero or less.

Our analysis considered L&LAE reserves on a net basis, by carrier. We did not review P/C L&LAE reserves by group, holding company, family of companies or other basis. Projections of L&LAE reserves, actuarial or otherwise, were outside the scope of the study. Had we reviewed loss and loss adjustment expense reserves on a net basis by group or family of insurers, the concentration of L&LAE reserves might have been interpreted differently. We choose a carrier level basis of review because we believe that each carrier exists within a group or family of carriers to play a unique role.

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