‘Industry’ Loss Reserve Studies Not Meaningful: Demotech Analysis

November 9, 2014 by Joseph L. Petrelli

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.

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 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.”