Reflecting on one of the trends that surfaced as property/casualty insurers announced 2023 financial results recently, AM Best expects reserve strengthening for accident years 2015-2019 to continue, the rating agency said in a new report.

As companies “finished reporting their results for fourth-quarter and full-year 2023, the numbers and the stories behind them indicate worsening reserve risk,” according to the special report published yesterday, “Heightened Risk Landscape Create New Challenges for Reserve Management.”

The trend of boosting reserves for the 2015-2019 accident years is expected to “hold over the short to medium terms, depending on an individual insurer’s reserving philosophy,” analysts wrote in the report listing the following challenges to time-tested actuarial reserving methods:

  • Distorted loss payment patterns created by a COVID-driven “hiatus in the economic and insurance ecosystem.”
  • Spiking economic inflation.
  • Worsening public attitudes toward large corporations.
  • More litigation financing firms.
  • Ubiquitous chemicals like PFAS and microplastics fueling lawsuits.

Describing the impact of COVID-19 on loss development histories, the report notes that construction, travel, education, commerce and the work environment went through radical changes. “The historical payment patterns that actuaries depend on to make decisions about the future were distorted by the main COVID years (2020-2022), which made projecting developments even more challenging.”

While the report doesn’t indicate any forthcoming impact on financial strength ratings of insurers and reinsurers, the report opens with a reminder from past AM Best reports that underestimating reserves has been the leading cause of insolvency over the years. The report’s authors also suggest adding reinsurance products, such as adverse development covers and loss portfolio transfers, as part of insurer risk management programs “may be one aspect to addressing volatility that could be caused by inadequate reserves.”

The report includes a section that reviews these options and the pluses and minuses. Among the negatives, “premium paid for the ADC is cash out the door, which could hurt the insurer’s investment income, particularly if reserves never penetrate the ADC.”

Still, the possibilities of bolstering capital and minimizing volatility are benefits for insurers to consider, the report says. The balance sheet impact “may be not only material and permanent, but also immediate,” the report says describing the capital boost benefit. “Other forms of reinsurance capital do not de-lever a company’s balance sheet as quickly or as meaningfully as a legacy transaction.”

“For some business lines, even a relatively small deficiency in current reserves could have a material impact on policyholders’ surplus and a company’s financial position,” the report says.

AM Best notes that the ideal portfolios for legacy reinsurance are non-core long-tailed casualty P/C lines.

In AM Best’s analyses, analysts consider risk factors related to the use of these reinsurance covers, including whether a transaction will have a positive or negative impact on earnings, reputation (“How will current policyholders view outsourcing any claims management?”) and whether divesting liabilities will help a carrier meet its target capital.

The report also briefly discusses emerging risks like PFAS and climate-related casualty litigation.