Liability Exposures surprise insurers

The recently released A.M. Best Claims Report for the Canadian property and casualty insurance market highlights several interesting trends in the structuring of company reserves and the actual impact of claims versus reserving estimates across the business lines. Most importantly, the 2000 Report shows a stark rise in liability-related claim costs over initial reserving for 1999.

Perhaps the most intriguing number in A.M. Best’s current Claims Report for the insurance industry relates to the development of prior year claims for the liability line of business. According to the Report, in 1998 the industry reported a favorable margin of $94 million on the run-off of claims from this line of business. In 1999, however, the run-off was reduced to a deficiency of $113 million. This is a dramatic swing of $207 million in a line of business where 1999’s direct premiums written amounted to $2.1 billion and net unpaid claims (reserves) were $5.8 billion.

A favorable margin on prior year claims is recorded when current estimates of a prior year’s unpaid claims indicate that those earlier estimates were more than necessary. An unfavorable development, or deficiency, on prior year claims is recorded when current estimates indicate that earlier estimates were insufficient.

Analysis of company data through A.M. Best’s WinTRAC P/C software reveals the different impact actual liability claims versus reserving estimates had on insurers and reinsurers. While a total of 222 companies are included in the WinTrac database, only 138 companies provided complete liability data for the five-year period 1995-1999, and the accompanying charts have been produced by splitting that data between the 22 reinsurers and the 116 insurers.

It is apparent from chart-1 that the liability line of business is proportionately more important to the 22 reinsurers at approximately 17% of total writings, than for the 116 insurers at approximately 11% of total business.

However, chart-2 shows that the claims development for the liability line has been more volatile for the reinsurers. While the total claims development has been favorable for both reinsurers and insurers alike, the 22 reinsurers experienced three years of favorable margin development for the liability line while the insurers recorded a favorable development in only 1998.

In addition, for the 22 reinsurers the annual change in the development of the liability line has accounted for more than 100% of the change in the total for all the lines of business. By comparison, only in 1997 did the change in the liability line represent a significant portion of the change in the total for all lines of business for the 116 insurers. The most likely explanation for the changes in the development of the liability claims is due to the “long tail nature” of the business–as such, it is notoriously difficult to estimate accurately.

However, it appears from the data that reinsurers have been able to estimate the quantum more precisely than the insurers have since a favorable margin has been recorded by them in three of the past five years. But, in 1999 it appears that both reinsurers and the insurers identified potential problems since they each recorded significant changes in deficiencies ($128 million for reinsurers and $81 million for insurers — see chart-2). This is perhaps understandable since the liability line is proportionately more important for the reinsurers (see chart-1).

Environmental issues, sexual abuse claims and leaky condominiums in British Columbia are all possible explanations for the unfavorable development recorded in 1999 by both the reinsurers and the insurers.

The bottom-line

The unfavorable development recorded in the liability line of business for 1999 is the major reason for the overall reduction in the industry’s margin for all lines of business for that year. The reinsurers recorded the bulk of the 1999 unfavorable development in the liability line of business (see chart-2). Except for 1999, it appears that the reinsurers were more accurate in their estimates than the insurers since they have recorded favorable margins in three of the past five years. However, the industry in total, in all lines of business, appears to be adequately provided or reserved since the favorable development in the other lines (especially automobile) has offset the deficiencies on the liability end. I wait with interest to see how the margins and deficiencies shake out in 2000 for the liability line of business for the reinsurers and insurers.

Chart 1

SOURCE: BEST’S WINTRAC P/C

NPW = Net Premiums Written

Chart 2

Margins represent the favourable run-off of prior year claims estimates.

Deficiencies represent the unfavourable develoment on the run-off of prior year claims estimates.