Fitch predicts p&c market reserve cushion to diminish in coming years

Canadian and U.S. property and casualty reserves were modest at year-end 2007, but Fitch Ratings predicts that reserve redundancy will begin to decline moving forward amid eroding market conditions and increasing accident-year loss ratios.
In its report, Fitch Ratings examines the industry’s reserves at year-end 2007, focusing on core reserves from the most recent 10 accident years, as well as losses tied to asbestos and environmental exposures.
“In the near-term, calendar-year earnings will continue to benefit from favourable reserve development from prior underwriting periods, but accident-year loss ratios are likely to increase materially from prior years as market conditions erode further,” Fitch Ratings reports.
The industry is in a typical spot regarding loss reserves following a hard market as insurers tend to underestimate the impact of market improvements on incurred losses during periods of positive rate increases and other underwriting challenges. This results in the development of a reserve cushion over time. “This cushion then diminishes as the hard market accident years mature,” the report continues.
Fitch’s reserve deficiency estimate is divided into four components:
1) the ten most recent accident-year exposures (US$17.4 billion US$18.0 billion redundant for 1998-2007); asbestos exposures (US$4.7 billion US$9.3 billion deficient); environmental exposures (US$2.3 billion – $3.2 billion deficient); and other latent exposures (US$2.0 billion – US$4.0 billion deficient).
At year-end 2007, Fitch projects that the industry’s net loss and loss adjustment expense reserves were US$0.9 billion to US$9.0 billion redundant.
“Reserving challenges are likely to increase in the near term as the soft market unfolds, with more uncertainty in projecting underwriting results in a period of rate reductions and loosening policy terms and conditions,” Fitch reports. “Compounding this uncertainty is the threat of increasing monetary inflation, which adds further difficulty in estimating loss costs, particularly in longer-tail business lines.”