Heading into 2024, AM Best maintained a stable outlook on the overall U.S. commercial lines sector. This was based on our expectation that the segment as a whole will remain profitable and resilient in the face of near- and longer-term challenges and that risk-adjusted capitalization for the vast majority of carriers will remain sound.
Underlying this rationale are our stable outlooks for the commercial property and workers compensation lines, as well as a positive outlook for the excess and surplus lines market.
However, that same level of optimism does not apply to most of the U.S. casualty segment—particularly commercial general liability and auto liability. The same can be said for non-medical professional liability, which includes management liability lines such as public institution directors and officers, employment practices liability and cyber liability.
Near-term concerns include stubbornly high broad-based economic, medical and social inflation, the latter including jury awards and litigation costs, which continue to rise. Casualty reinsurers are voicing concern about social inflation and rate adequacy, which could lead to higher reinsurance costs and tighter terms and conditions on casualty covers.
Commercial lines insurers, unlike their personal lines peers, reported robust underwriting results through the third quarter of 2023. They are expected to continue to do so, driven by strong net premiums earned on the heels of prior-year rate increases for most of the major commercial lines of business. This has occurred despite some recent weakening in pricing gains, as well as growth in net premiums written, due to the U.S. economy’s continued expansion.
Here’s a look at the recent performance within some major casualty lines of business through the third quarter of 2023:
▪ Workers Compensation: This has been the P/C industry’s most profitable line for the past several years, with favorable loss development contributing over $5 billion in earnings in 2022. This segment recorded a pure direct loss ratio of 47.9 through 3Q/2023 (3Q/2022: 47.5) Both medical and indemnity severity have increased, but the magnitude has been largely outpaced by increased wages. Long-term indemnity severity remains lower than wage inflation, while the medical severity trend remained in line with overall medical price inflation.
▪ Commercial Auto: This line’s pure direct loss ratio ticked upward to 74.5 through 3Q/2023 (3Q/2022: 70.1). This line of business has continued to be plagued by costly claims attributable to poor driving habits and climbing medical costs. Although renewal pricing increases have averaged around 7 percent, these have proven insufficient to keep pace with rising loss costs.
▪ General Liability (Occurrence): Premiums in this line have grown by double digits for primary insurers in recent years. Net incurred losses grew by almost 25 percent year-to-year in 2022, reflecting larger underwriting losses, including adverse reserve development of more than $3.5 billion. As of 3Q/2023, the line’s pure direct loss ratio of 65.5 was down slightly from the prior-year period (3Q/2022: 66.1). Social and medical inflation have contributed to higher claim costs, while the number of claims has increased for virtually all casualty lines involving claimant-attorney representation for several years.
▪ General Liability (Claims Made): The line’s pure direct loss ratio was 48.9 through 3Q/2023 (3Q/2022: 49.8). The U.S. professional liability segment experienced strong growth from 2018-2022, driven largely by directors and officers liability (D&O) and cyber. But the impact of headwinds such as high economic inflation, social inflation and more aggressive antitrust laws suggest that recent year reported results may be more favorable than they ultimately prove to be. Furthermore, challenging economic conditions have suppressed IPO and M&A activity, and cyber attacks continue to increase infrequency and severity.
The most notable adverse trend facing U.S. commercial insurers, and the economy overall, has been the persistent inflationary pressure, which is not only affecting the property lines sector. The general rise in claims demands, settlements and judgments (social inflation) is enormously relevant for casualty lines (if more difficult to measure and anticipate than the costs of goods and services), as these trends not only impact future claims but also require continual re-evaluation of existing claims reserves. These lines, with the exception of commercial auto liability, benefited from material favorable loss reserve development during most of the last decade. Over time, however, the extent of favorable development has diminished, due in part to the rise in claims costs—particularly in the general liability and management liability segments (the latter largely comprising non-medical professional liability), both of which have seen adverse development in more recent years.
Although commercial auto renewal pricing increases have averaged around 7 percent, these have proven insufficient to keep pace with rising loss costs.
In addition to well-established areas of litigation, the emergence of new types of liability is ever-present for commercial casualty insurers, particularly in light of evolving legal and social attitudes toward dietary and other substances, the implementation of new chemical and materials technologies, genetic engineering research, and other trends. Additional concern appears warranted with respect to potential long-term liability costs related to (1) herbicides and pesticides in use over the course of multiple decades, (2) “nutraceuticals” such as dietary supplements, and (3) “forever chemicals” in commercial household products and industrial production facilities that could lead to bodily harm or impair real property asset values or affect drinking water. All of these issues may prove to be fertile ground for mass tort litigation in the years ahead.
Commercial insurers also face challenges assessing the nature and scope of exposures relating to climate risk. The variability in the commercial lines’ reported results in recent years is largely a reflection of the variability in catastrophe losses each year.
Also worthy of note is the evolution of litigation financing, in which third-party investor groups (often private equity firms or hedge funds) provide upfront financing to plaintiff attorneys involved in personal injury and liability litigation in return for a share in the ultimate jury award or settlement. Litigation financing has become a significant factor in mass tort litigation and can be a major contributor to the lengthening of claims settlement periods and costly verdicts.
A notable tailwind for casualty insurers, however, is the significant strengthening of yield for insurers’ fixed-income securities portfolios (which had supported overall operating performance), as free cash flows and maturing fixed-income portfolios continue to roll over into sharply higher interest-rate bearing bonds. Over the past decade, insurers have had to generate more substantial underwriting profits to offset the impact of persistently low interest rates. Insurers’ challenges in the next year or two will be to avoid sacrificing underwriting pricing adequacy and to maintain adequate risk-adjusted returns.