Casualty (re)insurance is often overshadowed by developments in property lines. As the last two years have shown, the human impact and devastating damage caused by catastrophes such as hurricanes, typhoons, wildfires and earthquakes tend to dominate the headlines, according to Julian Alovisi, Head of Research and Publications, Guy Carpenter.

The casualty market rarely gets the same level of attention, even though it has been the main catalyst of nearly all past market turns. Its underlying complexity, driven by human behavior and other (medical, legal and economic) factors, makes it difficult to assess financial losses and, by extension, the adequacy of underwriting. Long-tail risks are particularly vulnerable to unanticipated developments that are not priced at policy inception. Indeed, the asbestos crisis of the 1980s took seven or so decades, and a revolution in injury law, to manifest.

Claims Environment

Favorable conditions in liability lines for example, a benign inflationary environment and historically low loss experiences have nevertheless supported underwriting results for much of the current decade. This period of low loss cost inflation and frequency has enabled carriers to release redundant reserves into earnings, thereby compensating for historically low investment yields, as well as elevated catastrophe losses.

But the situation now appears to be changing as a combination of higher loss costs, increased severity and growing instances of adverse reserve development are squeezing carriers margins in a number of liability classes. Social inflation appears to be the main driving force behind these trends. Indeed, spiraling litigation, higher costs and more generous jury awards (and attitudes) have coincided with some prominent carriers rethinking underwriting appetites and pulling back or withdrawing capacity.

Although these factors can be difficult to quantify, some areas are clearly seeing increasing pressures. Federal securities class actions (and costs) in the United States, for example, have risen in recent years. The number of companies being sued for securities claims has nearly doubled in the last three years as more suits are being filed for mergers and acquisitions deals and significant stock price movements. Median settlement values jumped last year to reach a decadal high of USD 13 million, according to National Economic Research Associates. This has also coincided with rising legal services costs.

This is indicative of increased loss frequency and severity observed in a number of business classes, including the U.S. commercial motor market most prominently, but also directors and officers, medical malpractice, general liability and other liability lines.

Lurking Threats

It typically takes a significant amount of time for long-tail claims trends to emerge fully. The loss potential associated with opioid addiction is just one example that could have serious implications for the sector on this front. Multiple lawsuits have been filed against pharmaceuticals and other companies involved in the distribution and sales process, and a surge in claims has already led to coverage disputes between these companies and their insurers.

Furthermore, the degree of change that is to come with technological disruption, the shift from tangible to intangible assets and the transfer of liability from individuals to large manufacturers has the potential to redefine liability risks like never before.

There is therefore growing evidence that loss cost pressures are starting to build in the casualty market. The recent (and often notable) pricing increases observed in several business lines support this theory. Given the smaller pool of carriers operating in the global casualty market, replacing lost or reduced capacity can be difficult, making it more vulnerable to capacity constraints should carriers claims assumptions change.

The potential implications of a tightening casualty market are clear. The difficulties posed by estimating total ultimate losses for long-tail business mean sector capital levels become uncertain when reserves, which can represent multiples of annual earned premiums and equity, begin to appear deficient even at the margin.

While reserve adequacy is notoriously difficult to predict, the analysis shown in Figure 1 implies that the sector may be in a danger phase in which carriers are continuing to release reserves even as accident year experience indicates that redundancies are diminishing. The overriding trend in recent years towards fewer reserve releases is clear to see and may partly reflect the deteriorating claims environment. Notably, the second quarter of 2019 was only the second time since 2004 that the sector experienced net reserve strengthening.

At the very least, our proprietary research indicates that carriers can no longer rely on reserve redundancies to protect or enhance profits as they have done since the mid-2000s.

Figure 1: Calendar Year Reserve Development by Quarter for Top 35 Global P&C Carriers versus Accident Year Reserve Experience 1998 to Q2 2019

Source: Guy Carpenter

Value of Reinsurance

This backdrop points to the value of reinsurance solutions. Freeing up capital can enable carriers to enhance capital management strategies and to improve capital efficiency. Transactions can take many forms, including new quota share programs, adverse development covers and loss portfolio transfers. Although market conditions are tightening in some areas, cover remains available for those with the foresight to move quickly. The obvious implication is that now is the time to seek protection.

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Emerging From the Shadows: Casualty - GC Capital Ideas