The idea that carriers release loss reserves when property/casualty insurance markets soften and strengthen them in hard markets is more than a theory, according to a new analysis by rating agency A.M. Best.
“The loss and LAE [loss adjustment expense] reserving cycle appears real for most of the property/casualty industry,” A.M. Best analysts conclude in a special report published on Monday.
The analysis also reveals that the link between reserving practices and market cycles is stronger for stock companies than mutuals. In addition, by type of business, A.M. Best found the strongest links for commercial casualty and surplus lines, with reinsurance and personal lines exhibiting weaker links.
For only one line—commercial property—there was no statistically significant relationship at all, according to the rating agency’s report titled “P/C Loss Reserves: Do Reserving Cycles Really Exist?”
(Editor’s Note: Carrier Management published research by Illinois State University and Pinnacle Actuarial Resources in February, which reached a similar conclusion about differences in reserve changes for stock and mutual insurers. See related article Earnings Management Persists; Sarbox Has No Impact on P/C Reserving.)
To reach its conclusions for each category of business and for the P/C industry in total, A.M. Best analyzed two sets of data for the 22-year period from 1990 through 2011:
- The change in prior accident-year net loss and LAE reserves as a percentage of prior year-end net carried reserves.
- Net earned premiums adjusted for changes in U.S. real gross domestic product.
By adjusting the net earned premium data, Best analysts attempted to produce a rough measure of pricing changes, or P/C insurance market conditions over time.
Arraying the two sets of data graphically by year reveals the familiar post-2001 hard market spike—for both the earned premium and change in reserves line graphs—for the U.S. P/C industry overall and for several other categories (stock companies and commercial casualty, for example).
Giving a more precise statistical measure of the relationships, A.M. Best analysts calculated correlation coefficients for each of eight categories (of ownership and business segment) analyzed. For the industry as a whole, A.M. Best found a strong statistical relationship, with a correlation coefficient of 0.79 between changes in adjusted net earned premiums and the prior-year reserve ratio changes. (A correlation coefficient of 1.0 indicates a perfect positive correlation.)
Correlation coefficients for other categories were:
- U.S. P/C Stock Companies: 0.74
- U.S. P/C Mutuals: 0.61
- U.S. P/C Reinsurance: 0.40
- U.S. Surplus Lines: 0.85
- U.S. Personal Lines: 0.34
- U.S. Commercial Casualty: 0.77
- U.S. Commercial Property: -0.03
For each category, the analysis also looks at correlations when the relationship is adjusted back or forward one year or two to explore timing aspects of relationships. For example, for the total P/C industry overall, correlations were still apparent but weaker when adjusted forward (0.64) or back (0.67) one year.