A growing minority of voices in recent weeks have expressed their conviction that the industry in the aggregate will suffer loss emergence in the 2021, 2022, and 2023 accident years. If this casualty heterodoxy proves out it has scope to significantly upend commercial lines dynamics.
Likely implications include insurers disappointing on results in the aggregate, and scope for more Argo’s to emerge. An acceleration in rate-taking would be likely, along with a fresh push on cedes from reinsurers.
Most importantly, a decade long streak of reserve deficiencies could prompt insurers to take a more fundamental look at the US casualty market, and significantly scale back risk appetite. If they move dramatically enough the impact on the real economy could trigger a paradigm shift on loss-cost inflation.
Stepping back, the consensus view for some time has been that the US casualty market has a reserving problem in the 2013-19 years, with the problem likely most acute in the later accident years.
These years were reserved in a period of soft pricing, high competition, and benign inflation. Loss-cost inflation subsequently surged based on the collection of phenomena typically reduced to the epithet “social inflation”. These include an anti-corporate sentiment, mistrust of elites, growing inequality, and the industrialization of claims including via the use of litigation financing.
Adverse claims trends were undeniable by 2019, but the pandemic delayed the crystallization of the losses. After a period of pretending and extending, much of that bad news is now being recognized with a series of high-profile charges taken to true-up 2016-19 in Q4. Insurers bolstering reserves are behaving exactly as you would expect, the orthodox school says - a charge is simply par for the course.
The orthodox view holds that casualty portfolios were fixed by a combination of 1) heavy portfolio remediation; and 2) the benefit to the 2020 accident year and the first half of 2021 from the Covid-19 get-out-of-jail-free card on frequency.
Critically, alongside the rate rises, T&C improvements and retention increases that were imposed through 2019-23, the market also passed through a historic compression of limits. In some cases, $25mn lines became $5mn, with dramatic limit reductions evident across the tower.
According to those who believe the orthodoxy, this underwriting remediation work (paired with Covid benefits) allowed casualty books to reach rate adequacy. They believe that high-single-digit rate rises are still needed to pace loss trend. Some also stress that there are pockets of concern where more aggressive rate-taking is needed, for example commercial auto, lead umbrella for large clients, and medmal.
Overall, though, the orthodox view is that the re-underwriting created scope for insurers both to drop loss picks to improve current-year margins, and to simultaneously engage in balance sheet repair. That fat in 2020-23 is perceived as a driver of future profitability, or a means of offsetting the drag from old accident years for those who need it.
Some who espouse this view believe the early 2000s offers a historical parallel. At that time following the appalling calendar-year results in the early 2000s driven by adverse development on the mid-to-late 1990s accident years, the industry forced through major underwriting changes. As it did so, fear persisted around the performance of the new accident years.
The 2002 underwriting year and those after it showed a major improvement in accident-year loss ratios on an ultimate basis. The orthodox view says that a similar pattern will be followed this time.
Unpacking the casualty heterodoxy
The heterodox view laid out recently in private by a slew of senior sources across live, legacy, broking, insurance and reinsurance is that the industry does not have the ground beneath its feet on the 2021-23 accident years.
One senior legacy source argued that when the sharp uptick in loss-cost inflation resulting from social inflation became evident in 2019 the industry should have step-changed loss trend to 9-10%.
Instead, most insurers slow-walked loss trend up 50-100 basis points at a time over multiple years towards mid-to-high single-digits by 2023.
Add to this that recent reserve additions suggest that insurers have used the wrong base for reserving 2020 and beyond, given they are materially lifting 2016-19 reserves now.
Reserve additions have been heavily focused around the soft market years, but some are moving quickly to recognize issues in recent years. One senior carrier source at a firm that is not public said that it had taken a reserve charge in calendar-year 2023, with 40% of the deterioration driven by accident years 2020-23.
Some isolated cases also appeared in public company disclosures. Markel was an outlier in public companies reporting charges given that it took some adverse development on accident years 2021 and 2022. AIG also strengthened reserves in US ‘other casualty’ by $26mn (on a base of $795mn) for the 2022 accident year, according to its 10-K, despite overall favorable development including a $23mn release from 2020.
The legacy source also emphasized that a “bid-ask” spread had emerged on legacy transactions in recent months with a series of large books brought to market and then ultimately retained by the potential cedants. They maintained that the key driver of this was newer years, with the need for reserve adjustments on old years well understood.
Another legacy market source said that 2021 and 2022 accident years were developing as expected, but said that insurers that were rushing to take down reserves here did not have good support in the data.
Insurance Insider US research has frequently cautioned against early reserve take-downs in its work.
Reserve true-ups always hurt management credibility. If reserves are stripped earlier and then have to be replenished then credibility is destroyed.
Reduced confidence, increased complexity
Even those that did not subscribe to the heterodox view said that they have reduced confidence on the adequacy of recent years, as claims data deteriorates.
Asked if he was confident on the 2021-23 reserving at his company, a senior executive at a commercial lines carrier said: “I don’t know.”
And this may be the best way to express the developing picture. The industry’s confidence that there is redundancy in the 2021-23 years has declined almost month-on-month over the last nine months. Doubt is emerging that enough was done to fix the casualty market – but, of course, ultimate loss ratios are hard to judge a couple of years out with any confidence.
A lot of factors are contributing to the unusually high degree of market uncertainty at this juncture. Covid-19 created significant distortions, most specifically around increased claims latency that pushed verdicts and settlements into later years that were highly inflationary. The impact of this latency should drop out over time as the bulge of delayed claims makes its way through the system.
Other clouding factors include signs that some insurers are just giving up limits rather than spending money to contest claims.
“Some companies would rather settle than fight and spend half the limit on litigation,” one executive said.
With multiple insurers privately discussing increased investments in claims and efforts to improve cooperation in resisting the plaintiff bar, there are questions as to whether this trend will continue.
There is also opacity around the degree to which some of the reserve strengthening we are seeing on old years is essentially opportunistic earnings management from executives that felt 2023 calendar-year results didn’t need to be as good as they would have emerged.
Last of all, there is no precedent for the degree of limit compression that we have seen in this firming phase. So even if the industry has been slow to recognize trend, this is likely to provide a high degree of mitigation.
A few quick caveats. Generalizations are always over-simplifications and that is particularly true in the US liability market that is extremely diverse. Outcomes will be different for E&S and admitted companies. Are we looking at general liability for a low hazard client or trucking? Is the client small or large? Or are we looking at public D&O? How much reinsurance did the insurer buy? Do they have a loss portfolio transfer in place?
Then you have questions about how aggressively loss picks were moved down in 2020-23. And all that is before you engage with the massive spread between good underwriting businesses and bad ones – with the spread top to bottom in casualty loss ratios often as much as 80 pts.
So what are the implications?
If the US casualty market is under-reserved for the 2021-23 accident years, there are a number of important implications.
1. The commercial lines industry is not as healthy as we thought it was
Most industry-watchers have been bullish around commercial lines writers prospects as a result of the Long Firming phase of the cycle. Along with a reset in interest rates, this seemed likely to position insurers well to deliver strong calendar-year results over the next couple of years.
If casualty reserving proves a multi-year drag on returns the promise of the pricing cycle will not be kept, and insurers will disappoint on the downside.
Some insurers would no doubt be caught out and we could see another wave of forced or semi-forced sellers in the mold of Argo where investors lose confidence that they have an independent future.
2. More aggressive rate-taking is needed in casualty insurance, and reinsurers may redouble efforts to squeeze cedes
We have written already about uneven and incomplete evidence of a micro-cycle brewing in US casualty, and one underwriting source this week said rates in lead umbrella are up to close to 20%, while a broking source said that E&S casualty is running at 10-15%. (This is yet to show up in CIAB data through Q3.)
If the recent accident years are underwater, insurers will need to ensure that micro-cycle becomes entrenched and broad-based to drive returns.
Some – including sources at cedants – believe it is possible that reinsurers will resume their efforts to drive down ceding commissions, and potentially succeed over the next 12-18 months. (Of course, there is a degree to which a few points of commission is a sideshow to the main rate discussion between insurer and insured.)
3. US casualty is more broken than has widely been perceived
Casualty has always been the insurance company killer, not cat. And the market has been watching developments in the class nervously for years.
But if the more recent years which looked likely to be profitable prove otherwise, then insurers need to grapple more fundamentally with the issues of the class.
Ultimately, it may foreground the need for widespread tort reform. This, however, seems unlikely unless a true availability/price of cover crisis emerges for clients and creates pain and disruption in the real economy.
That seems a long way off. But if the heavy lift of 2019-21 didn’t fix the casualty book, then it is possible insurers will dramatically alter their risk appetite in this area. If they are willing to go far enough – and it’s a big if - it could result in a paradigm shift.
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