Best's Special Report: Heightened Risk Landscape Creates New Challenges for Reserve Management

Moving past the COVID-19 era economic fallout has given rise to indications of worsening reserve risk as insurers report financial results for fourth quarter and full-year 2023, according to a new AM Best report.

A new Best's Special Report states that the risk landscape evolving from the pandemic is one that includes escalated reserve risk, especially for the long-tail lines of insurance business. For some business lines, even a relatively small deficiency in current reserves could have a material impact on policyholders' surplus and a company's financial position. Projecting a company's future bottom line and financial needs is pivotal in moving forward, with reserves estimations being both an art and a science.

"Theoretical reserving methods may involve complicated math and risk modeling, but the process enables the actuary to arrive at a best estimate that will be used by management to arrive at a final number reported on a company's balance sheet," said Christopher Graham, senior industry analyst, Industry Research and Analytics, AM Best.

However, macroeconomic factors stemming from main COVID-19 years (2020-2022), created a hiatus in the economic and insurance ecosystem. The report notes that construction, travel, education, commerce, and the work environment went through radical changes, along with governmental decrees, regulations, and the legal system and insurance shifts that followed. This distorted the historical patterns that actuaries depend on to make decisions about the future.

In addition, economic inflation spiked. The average annual inflation rate was 2.55% from 2000 to 2023, and 1.45% for the years 2015 to 2019?accident years that already had adverse reserve development. However, the average rate of inflation was 5.6% from 2021 to 2023. Actuaries use inflation estimates as one of many factors to predict increases in severity and losses. Given the inflationary spikes, severity could be underestimated, leading to actuaries to raise prior projections.

Several other factors are contributing to the reserve risk pressures, including:

• The rise in punitive damages in class action lawsuits brought against large corporations, which are complicating loss estimates;
• The growth in litigation financing firms, which are utilizing more technology with the outcomes creating distortions in payment patterns;
• Ubiquitous chemicals such as PFAS and microplastics have caused many lawsuits. In addition, climate-related casualty litigation and mental health issues related to technology addiction have the potential to create issues in general liability, product liability, and clean-up costs.

To access the full copy of this market segment report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=342048.

AM Best is a global credit rating agency, news publisher and data analytics provider specializing in the insurance industry. Headquartered in the United States, the company does business in over 100 countries with regional offices in London, Amsterdam, Dubai, Hong Kong, Singapore and Mexico City. For more information, visit www.ambest.com.

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