Liability claims have been lower than expected in recent years, which has boosted insurers’ profits despite a decline in liability rates. But new risks and stronger economic growth will increase claims severity and generate more demand for liability insurance.

That’s the major conclusion of Swiss Re’s latest sigma study “Liability claims trends: emerging risks and rebounding drivers.”

Due to economic and social factors such as low inflation, low wage growth, tort reform, and improvements in medical care costs, liability claims have been lower than expected since 2008.

Indeed, in a highly unusual historical development, the report added, in many countries nominal claims growth has actually been significantly lower than nominal growth in economic activity since that year.

In the United States, for example, the recession lowered the frequency of claims because employment in high-risk industries, such as manufacturing and construction, declined more than service sector employment. The economic drivers appear to have also reduced the severity of claims as medical expenses and wage growth trended downwards. The crisis curbed wage growth through weak labor markets, while the slowdown in health expenditures started earlier.

The report contended that the effects of tort reform provided a one-off benefit and will no longer suppress claims growth to the same degree.

Claims Growth to Revert to Pre-Crisis Levels

Over the long term, claims growth typically outpaces economic growth and the expectation is for a return to this more normal growth path, which in turn will push up demand for liability insurance.

The report warned that new risks and stronger economic growth will increase claims severity and generate more demand for liability insurance.

Emerging Risks

A number of technological, social, and regulatory changes will drive liability claims in the near future. . The “next asbestos” could stem from a variety of risks: nanotechnology, hydrofracking, risk accumulation in the food production and processing chain, or from the broad scope of environmental risks, the report said.

Insurers are also concerned about the potential for risk accumulation, in which the insured losses from one event affect multiple companies, countries, industries or lines of business.

Catastrophic losses can also occur from long latency claims, especially those in which new damage causes may be discovered after many years of writing the same business, such as in construction or product defect claims. “For example, the danger of asbestos has haunted insurers for many decades as plaintiffs have discovered new legal channels for claims,” the sigma report added.

“With global ever-increasing interconnectivity – via cyber links and supply chains – the risk of casualty catastrophes is rising,” explained Jayne Plunkett, Swiss Re’s Head of Casualty, in comments accompanying the report.

Depletion of Claims Reserves

Redundant claims reserves from prior-year claims have been another factor supporting insurers’ profitability in recent years. However, an increase in liability claims will drain reserves, and an accelerated depletion of reserves in the case of severe claims could erode the profitability of existing books of business, the report continued.

Profits also could be constrained if competitive forces keep prices from catching up with the
claims trend.

Liability risks are challenging to underwrite and price due to their long-tail nature, which often results in claims being settled many years after business is written.

Insurers need to take advantage of their underwriting expertise to improve pricing, the report said. Likewise, they must maintain capital strength to manage the long-tail nature of the business and the rising claims costs, such as those from the growing litigation funding industry.

Innovation Required

Insurers need to innovate to capture market opportunities. With Big Data and forward-looking models, insurers can perform statistical analysis to better understand the key drivers of risks, the sigma report went on to say.

While predictive models can anticipate future outcomes under relatively stable conditions, forward-looking models reflect the cause-effect chain of liability losses, allowing for complex relationships between observable risk drivers of claims frequency and severity, often using a scenario-based approach, the report noted.

For commercial lines, the use of Big Data and predictive modeling is nascent but increasing. To demonstrate this point, the sigma report quoted a Towers Watson Insights report, “2013 Predictive Modeling Benchmarking Survey,” published in March 2014, which said nearly half of workers’ compensation writers had adopted some form of predictive modeling by 2013, up from 38 percent in 2012.

In general liability, a third of the survey respondents used predictive modeling in 2013, up 7 points over the prior year, according to Towers Watson.

Industry participants and consulting firms have used predictive models to manage D&O portfolios, given the availability of class action lawsuit and correlated financial data.

The sigma report said that many commercial fleets already use telematics devices to track the movement of vehicles and cargo. Ever-smaller tracking devices and nanotechnology could allow such data collection to extend to insurance for chemical and pharmaceutical industries, for example.

At the same time, model analytics can improve fraud detection by combing data from different sources, which can identify suspicious behavior and reduce information asymmetry, thus helping curb claims.

Topics Trends Carriers Claims