Breaking News
There is something important you should know!
Michelle Harnick, Managing Director Contact Given that the leading cause of financial impairment of insurance companies is inadequate reserves and our view that a reserve "cycle" not only exists but may soon enter a period of adverse development, Guy Carpenter has spent considerable resources researching and building models to better understand and manage reserve risk. The Under-Reserving Problem Under casualty policies, the insurer agrees to compensate policyholders when they are legally required to compensate other parties that have suffered injury or property damage. Normally there is a significant lag between the date of an accident and final payment of the claim. Upon notice of a claim an insurance company sets up reserves - funds set aside to pay the claims. However, reserving is hardly a science, as many unknown factors can come into play and affect reserves, both positively and negatively. For example, consider the case of asbestos reserving. The latent nature of asbestos exposures combined with novel coverage interpretations and adverse legislative rulings resulted in dramatic reserve increases for the industry in the late 1990s and early 2000s. The end result was significant declines in surplus, negative impacts on calendar year earnings and negative rating actions. These reserve shocks impacted capital for reserves. Rating agencies, risk in the coming years. It is generally acknowledged that the recent positive earnings enjoyed by the industry have been supported by the continued release of reserves on older accident years, leading to a decline in the industry reserve strength and therefore a smaller margin of safety. While industry reserves appear adequate, small changes in trend assumptions can put significant negative pressure on companies' reserves, surplus and calendar year earnings. Of significant concern to the rating agencies is a change in economic conditions, for example inflation, that detrimentally impacts both sides of the balance sheet. Since calendar year loss trend incorporates a component of inflation, which may be correlated with interest rates, a period of dramatically increasing interest rates may coincide with increasing loss trend. In such a case there will be a concomitant shock to both sides of the balance sheet - increasing interest rates will reduce the value of the bond portfolio by an amount that depends on its duration, while inflation induces adverse development on reserves requiring a reserve correction. The result is a "double whammy." In fact, many companies believe the biggest challenge they face at the enterprise level is managing the tension between the risk of inflation and the threat of deflation. This source of uncertainty may lead a firm to sacrifice yield by investing in assets with a much shorter duration than its liabilities. A New Model To assist our clients in managing reserve risk we have developed MetaRisk® ReserveTM, a software tool that models the interplay of future calendar year trend and reserves. Insights gained from this tool enable companies to more effectively allocate capital and set strategy. Additionally, Guy Carpenter, in collaboration with our sister company, Oliver Wyman, produces an annual Industry Risk Benchmarks research report, which provides risk benchmarks by line-of-business, mean loss ratios, loss ratio volatility, reserve volatility, inter-line correlations and cycles. The research is based on a proprietary study of an extensive database of industry information incorporating the reported financial results of hundreds of insurance companies over a 30-year timespan. Insurers will find the benchmarks useful in parameterizing the risk assumptions used in economic capital models. MetaRisk Reserve coupled with the Industry Risk Benchmarks research reports has the following capabilities:
- Provides a more realistic view of both the mean reserves and the volatility around those reserves.
- Measures historical calendar year trends.
- Forecasts future trend risk.
- Analyzes the historical underwriting cycle.
- Gauges sensitivity of reserve position to future cycle.
- Helps understand the volatility of ultimate loss ratios by line-of-business and by firm type.
- Provides industry benchmarks on the volatility of changes to reserve estimates by analyzing how the ultimate loss changes from its estimation of 12 months of development from the accident year to 120 months of development.
- Estimates correlation matrices between lines of business for both ultimate loss ratios and reserve development over 12 months and 120 months.