Analysts at Morgan Stanley believe that the risk of adverse development in property and casualty (P&C) re/insurance reserves is likely to heighten over the coming years, potentially leading to a major earnings headwind.
The firm’s annual actuarial reserve study revealed an overall industry reserve deficiency of $4.3 billion relative to $615 billion of carried reserves.
While this deficiency is comparatively small, it continues a trend towards weakening reserves that has been underway for the past 10 years, with favourable development falling from $14 billion in 2013 to $4 billion in 2016.
Analysts also noted that the bulk of 2017’s anomalous $13 billion development emanated from workers’ compensation and short-tailed lines, while most other lines experienced declines.
Morgan Stanley does not consider this dynamic to be sustainable, and expects the risk of potential adverse development to accelerate as support from workers’ compensation reserves wanes.
Additionally, data shows that favourable reserve development slowed over each consecutive quarter of 2018, dropping from 2.8% at 4Q17 to 1.8% at 1Q18, then 1.6% at 2Q18 and 1.2% at 3Q18 (when measured as a percentage of earned premium).
Analysts added that a slowdown in reserve releases will pose a major earnings headwind or even balance sheet erosion for the P&C re/insurance industry, which released around $30 billion of prior year reserves in 2017.
Reserve releases contributed a total of $73 billion to industry earnings in 2010-17, accounting for roughly 20% of industry operating earnings, which cannot be sustained given the deteriorating cushion, Morgan Stanley argued.
The firm estimated that global reinsurers Axis, Everest Re and RenaissanceRe have the most excess reserves, while primary carriers W.R. Berkley and Travelers have the thinnest cushions.
It also considers to Chubb to have solid reserves and believes that AIG has improved to a modest cushion following significant reserve strengthening, reinsurance with Berkshire Hathaway, and more conservative reserving.