Recent Legislative and Judicial Developments in Continental Europe Affecting the Casualty Insurance Industry  is the latest installment in Guy Carpenter & Company Ltd.’s (”Guy Carpenter’s”) legislative update series, designed to provide our international clients and markets with a concise overview of key trends in the Continental European legal environment. These issues have had an impact on insurers and reinsurers or are expected to have an effect in the near future.

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Jessica Leong, Lead Casualty Specialty Actuary
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By extrapolating reserving trends, it may be possible to assess the sector’s reserve adequacy. Two cyclical patterns are clear.

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Jessica Leong, Lead Casualty Specialty Actuary
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As demonstrated in Figure 1, carriers released more reserves in 2011 than in 2010. This was in contrast to the general expectation for reserve releases to taper off from their peak in 2008. By analyzing the data closely, it becomes apparent that much of the 2011 calendar year redundancy was from the general liability - claims occurring line of business, shown in Figure 2 (the dotted lines again represent the movement in 2011). Accident years 2008 and 2009 for the general liability - claims occurring line show an unexpected downward turn in 2011, indicating more reserve releases than expected. This is similar to the downward turn for accident year 1992 in 1995.

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Aaron Bueler, Managing Director
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Rate increases and an apparent decrease in the use of carrier discounting were encouraging signs for an improving market. However, other headwinds remained - depressed investment rates, reserve development, medical trend (including pharmacy) and slow job growth were still major challenges to the industry. The workers compensation line is still struggling with profitability.

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Reinsurance renewals took place against a backdrop of plentiful capacity at July 1, 2012. Capital has continued to strengthen through the second quarter of 2012, moderating pricing pressures, according to a briefing released today by Guy Carpenter & Company.

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David Lewin, Managing Director
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Background

A Swedish manufacturer of industrial fire protection systems sold and delivered equipment to a manufacturing company in the state of Michigan, United States. In May 2001, two employees of the U.S. company were seriously injured during working hours when they tried to extinguish a fire on company premises.

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Over the course of 2011, 14 sponsors brought 18 transactions to the 144A market. In terms of transaction count, this places 2011 equal to 2009 as the second most active year in the history of the market. The 2011 sponsor class also included three first-time sponsors and the inaugural securitization of California state workers compensation losses associated with California earthquake events.

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A difficult market for workers compensation in 2011 is likely to extend into 2012. Deteriorating results in the primary market over the last few years have also had implications for reinsurers, which are under pressure from global property-catastrophe losses. Reinsurance rate declines were not the norm for the January 1, 2012, workers compensation renewals, as in past years. Factors ranged from sluggishness in the job market to the likelihood of reinsurer profit in other lines of business.

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At the start of 2012 renewals, the US casualty lines are showing stable to increasing underlying exposures, albeit in an uncertain economic environment. A recent positive development in the second half of 2011 was a slowdown in the decline of the subject premium bases for many casualty lines. Exposure and subject premiums appear to be stabilizing (and even increasing in some lines) as a result of the stabilizing economy. It appears that pressure on rates, too, has also leveled off as virtually all of the primary casualty lines have exhibited either flat to positive rate increases averaging in the low-to-mid single digits. And certain classes of business, including energy, chemical and life sciences are experiencing even higher rate increases at renewal as a result of the number of 2010 unprecedented losses.

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

MetaRisk® Reserve^TM: 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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