By Henry Gale

Feb 14 - (The Insurer) - Underwriters of casualty insurance policies have yet to gain the upper hand in their battle with so-called social inflation, an analysis of their growing disclosures of reserve strengthening related to recent accident years indicates.

Due to the time it takes for legal proceedings to be resolved, insurers continue to pay liability claims for years after policies' end dates. Other than economic inflation, trends such as the prevalence of litigation or the size of damage awards (collectively referred to as social inflation) are increasing the losses they incur for events that occurred in prior years.

There is now a broad consensus that the U.S. casualty insurance market initially underestimated the cost of claims for the 2014-2019 accident years (claims related to events which occurred between 2014 and 2019), particularly for lines of business such as general liability.

As a result, many (re)insurers have been forced to boost the reserves they hold to pay future claims relating to prior years, sometimes by hundreds of millions or billions of dollars. But the industry’s latest reserve charges suggest that adverse loss development in U.S. casualty is no longer confined to the 2014-2019 period.

Significant reserve deterioration for recent accident years would call into question how effective (re)insurers’ “corrective” changes to casualty underwriting since 2020 have been and whether more billion-dollar charges are to come.

2014 to 2019: the widely accepted problem years

By the end of 2023, U.S. insurers had strengthened their reserves by more than $31 billion for certain commercial liability lines across the 2014-2019 accident years.

The latest views of the industry’s loss ratios in each year are significantly higher, in some cases by more than five percentage points, than initially reported.

However, the financial impact on insurers was often cushioned by favourable loss development in other lines of business, notably workers’ compensation.

U.S. insurers disclose how their reserves have developed for each accident year and business line in annual statements to the National Association of Insurance Commissioners (NAIC), with the latest available data reaching the end of 2023.

By that point, the industry had not recognised any significant adverse development for the more recent accident years 2020-2022 in the lines that experienced the most deterioration during 2014-2019.

In fact, insurers’ estimates of incurred net losses for 2020 decreased by more than $1 billion (equivalent to one percentage point of the loss ratio) between the end of 2020 and the end of 2023.

This reflects satisfaction with the changes many insurers have made to their casualty underwriting practices since 2019 to improve the performance of their portfolios. These included premium increases, changes to risk appetite and coverage terms and conditions.

The latest reserving actions

During 2024, however, several (re)insurers have made significant moves to boost reserves for casualty business underwritten more recently.

Everest announced one of the largest reserve charges of recent years in January, totalling $2.39 billion gross of favourable development in other lines.

The $1.28 billion portion related to U.S. casualty insurance covered several accident years, but particularly strengthened reserves for 2020 to 2024.

This adverse development was driven by a combination of social inflation and concentrations of risk within its portfolio, Everest said. Increased frequency of claims was a key factor in Everest’s revised loss estimates across its casualty portfolio, while it also cited severity (the size of each claim) as a factor for auto liability insurance.

The rising costs of legal settlements and longer court processes were cited by Travelers’ chief financial officer Dan Frey as he explained a $250 million boost in the insurer’s general liability reserves for the 2021-2023 accident years last July.

Most of the reserve strengthening measures made during 2024 and tracked by The Insurer were either explicitly linked to recent accident years or said to cover a wide range of accident years without differentiating between pre- and post-2019.

More adverse development to come?

Speaking to sister publication E&S Insurer last November, Allied World’s CEO Lou Iglesias said that the insurer is now confident on its reserving for pre-2019 casualty business.

But it would be a mistake for anyone in the industry to be comfortable with more recent years, he said, citing economic and social inflation, legal system abuse, aggressive trial attorneys and litigation financiers. The cost of claims could rise further if these underlying factors remain or increase.

In September, the Swiss Re Institute said it expected social inflation in the US to continue for the foreseeable future. “While economic inflation is abating, there are no signs of a let-up in social inflation pressures,” it said.

“And in our view, the current rate of increase is unsustainable: we estimate the impact on casualty business in the U.S. will outweigh the earnings benefit of higher interest rates within one or two years.”

A social inflation index designed by the Swiss Re Institute, which aims to disentangle the growth in liability claims from economic inflation, shows values greater than zero since 2014.

Swiss Re attributes prior spikes in high social inflation in the 1980s and 2000s to material changes to tort law and expansion of access to mass tort. The current episode of social inflation characterised by more frequent large awards appears to be more sustained.

However, a report from broker Lockton Re last November argued that casualty losses for the 2020-2023 accident years are more likely to develop favourably than unfavourably.

“After a period where reserves have been inadequate, the pendulum is likely to swing the other way and result in a conservative approach to case reserves and IBNR (incurred but not reported) [loss] estimates for these more recent years,” the report said.

With social inflation an ever-more-prominent buzzword in the industry, underwriters’ hyperawareness of litigation trends could have prompted overcautiousness.

The broker also highlighted that the 2014-2019 adverse loss development had occurred during a soft insurance market, when premiums are stable or decreasing as insurers compete for business. Under-reserving was also a feature of the previous soft casualty market of 1997-2002.

When the market subsequently hardened, as insurers reduced their risk appetite and increased premiums, the industry’s reserves turned out to be more than sufficient. Loss ratios for the hard market accident years after 2002 turned out to be several percentage points lower than initially anticipated.

If the market cycle correlates with reserving trends, (re)insurers could be over-reserving for the 2020-2023 hard market, making further reserve charges less likely.

Inevitably, it will be several years before it is clear how adequate (re)insurers’ reserves are for recent accident years, but the latest spate of reserve charges for recent years are a worrying sign.

While some of the largest recent charges have been framed as an abundance of caution beyond necessity, such reserve boosts were not a feature of the 2000s hard market. On an industry-wide basis, reserves for those accident years went down nearly every year they were reported, not up.

With more insurers now disclosing strengthening for recent accident years, reserve deterioration risks becoming a new normal. Despite its best efforts, the liability insurance market, in the words of WR Berkley CEO Rob Berkley last month, "continues to be plagued by social inflation."