Impairment trends highlight perils of mismanaged reserves

A new study by A.M. Best gives ample evidence to the perils of mismanaged reserves for p&c insurers. The study, which covers U.S. insurers from 1969-2004, shows that most impairments when an insurer has their ability to write business limited by regulators due to financial difficulty were the result of reserving issues.In 37.2% of cases where a cause could be determined, deficient loss reserves/inadequate pricing were to blame. The second highest factor was rapid growth, cited in 17.3% of cases. This was followed by alleged fraud in 8.5% of impairments. “With the possible exclusion of catastrophe losses, A.M. Best believes all the primary causes of insolvencies in this study reflected some form of mismanagement.”Impairments followed general industry trends, spiking when financial or underwriting shocks pushed vulnerable companies over the edge. The worst year on record was 1991, although the years 2000-2002 approached that peak in terms of the number of failures. Nonetheless, A.M. Best notes, impairments remain rare, with an average rate of 1-in-125 companies in a given year. Even in the most challenging years, this rate only bumped up to 1-in-50 companies. More often, stock companies faced difficulties rather than their mutual counterparts. Also, failures were often small companies, and the majority were commercial lines writers, thus subject to wider swings in underwriting performance. In total, insolvencies cost the industry US$10.8 billion in post-assessment costs to pay insolvent insurer claims between 1969 and 2001.A.M. Best is cautiously optimistic about impairment levels in the near term, noting that 2002 was probably a peak for failures, with 2003 and 2004 expected to produce stronger industry results. Nonetheless, levels will remain above those seen in the late 1990s as insurers continue to struggle with reserve issues specifically from long-tail claims such as asbestos.