The question of how Q3 losses impact pricing has largely overshadowed the reserve issues, however, Morgan Stanley warned the industry not to ignore problems of weakening reserves as the downwards reserve development trend continued in 2017, and is expected to carry into 2018.
Favourable prior year reserve development slowed in Q3 2017 for the 38 publicly traded insurers tracked by Morgan Stanley, and reserve releases are expected to slow further in 2018.
Morgan Stanley analysts said the risk of adverse development will continue to rise over the next 1-2 years, particularly in Other Liability and Commercial Auto Liability.
In 2016s reserve report, Morgan Stanley warned “the industry’s overall reserve position is deficient by about $2.5 billion at YE16.”
In 2017, favourable prior year reserve development slowed by $857 million.
“Admittedly, there were some outliers in the quarter, including significant charges by AIG and AmTrust, as well as strong favorable development by Allstate,” said Morgan Stanley.
However, more firms saw adverse reserve development than improvement. For the total of 38 companies tracked by the equity analysts, the score was 25 to 13, worse to improved.
“In total for these 38 companies, favorable development was $40m in 3Q17, down $857m from 3Q16’s $897m.
“Benefit to the loss ratio was down 140bps, to 0.1pts from 1.5pts in 3Q16. The overall level of favorable development has declined YoY in each quarter of 2017.”
In the soft market environment, the industry has used reserve releases as a crutch to buoy up earnings.
Over the past seven years releases accounted for 20% of industry earnings, and industry experts have warned that reinsurers’ current profitability is based on the past. Thus further reserve deterioration will create a headwind on future earnings.
Morgan Stanley advised investors to watch company reserves closely, as stocks reaction to adverse reserve development can be quite harsh.
