January 2nd, 2012

Top GC Capital Ideas Stories on Reserves

Posted at 1:00 AM ET

Here we review the top GC Capital Ideas stories that have covered reserves in the last year.

MetaRisk® ReserveTM: How to Get Ahead of the Reserving Cycle: The impact of claims inflation on eroding returns is among the most vexing challenges that insurers face. Getting ahead of the reserving cycle would be a significant competitive advantage, but many carriers do not have the right tools at their disposal. As a result, the ability to hit target return on equity (ROE) levels is put at risk, and firm value hangs in the balance.

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Reserving Cycle Analysis Suggests Tightening Ahead: In recent years there has been a steady stream of reserve releases from insurers, which helped support financial results in the face of a weakening market and significant catastrophe losses. Heading into 2012, Guy Carpenter’s analysis of the reserving cycle suggests that the tide may be turning, and we may be heading into a period of reserve shortfalls.

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Guy Carpenter Publishes First Industry Risk Benchmarks Report: Guy Carpenter announced publication of its first Industry Risk Benchmarks report, which provides risk benchmarks for loss ratios and reserves, by line of business, for coefficient of variation (standard deviation/mean), correlation and cycles.

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Workers Compensation Reserve Risk Development: The Cat That May Be Lurking in Your Balance Sheet: Sudden natural disasters such as the tragic Tohoku earthquake in March are not the only catastrophes that can impact insurers’ balance sheets and policyholder surplus. Such well publicized natural catastrophes only account for about 10 percent of insurers’ notable capital and surplus impairments triggering regulatory action and concern. Of the remaining 90 percent, by far the single largest cause of impairments over the past 40 years (1969-2009) emanated from inadequate pricing and deficient loss reserves - resulting in approximately 40 percent of the cases.

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Chart: Property & Casualty Accident Year Reserve Development: Accident year loss experience is beginning to show signs of lower reserve margins. The chart below shows U.S. P&C industry reserve development by accident year since 2000. The reserving cycle is evident in the graph with adverse accident year loss development during the “soft market” years of 2000 and 2001 and favorable development between 2003 and 2007. The orange line in the graph shows the average initial loss ratio pick. The old reserving adage that “good years get better and bad years get worse” appears to be borne out here.

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Chart: Sustainability of Loss Reserves: Historically, one of the “big cats” has been sector under-reserving, which served as the backdrop for the last hard market. Over the last four years, reserve releases have featured prominently in the reinsurance sector and have continued to do so up until the third quarter of 2010. The chart below shows the contribution to reserve releases on the Guy Carpenter Bermuda Reinsurance Composite combined ratios from 2005. It is notable that the benefit from reserve releases has ticked up in the first nine months of 2010 by one full percentage point, to 8.8 points on the loss ratio. This has occurred during a year when many projected reserve releases would diminish.

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Chart: Incurred But Not Reported Levels a Measure of Reserving Trends: A clue which could point to a shift in reserving trends may be evident in U.S. P&C industry percentage of first year incurred but not reported (IBNR) figures, which, all else equal, is a measure of reserving conservatism. In the chart below, a trend of potentially diminishing conservatism can be seen. It is significant that the industry is, in aggregate, back to levels of around 30 percent - levels previously seen in the last soft market.

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