In our earnings preview, published earlier this week, we noted that, based on our reserve analysis, we would not be surprised to see additional reserve development this year.
Our analysis also discussed our concerns about releases coming from beyond the soft-market years, which were immature. In fact, for most of 2023, we maintained concern about post-Covid years, having witnessed multiple hard/soft market cycles and appreciating the lag in responding to trends.
Our call was prescient, as demonstrated by Travelers’ Q1 results. Although results were strong on an underlying basis, and personal lines continued to recover, the company noted that the business insurance segment reported no net reserve releases.
Breaking this down, the segment included $100mn of workers' compensation releases, offset by adverse development in recent years in general liability and run-off. Travelers’ stock sold off 7.4% on this adjustment and the EPS miss, but this is not bad news. It could, in fact, be good news.
The previously concluded 2023 year-end earnings were a mixed bag compared to our expectation of a greater degree of reserve adjustments. We get it. Management must walk a fine line between investor confidence, stock reaction, market opportunities, and balance sheet actions.
With Travelers’ results setting the tone for this earnings season, it gets easier for the rest of the peer group, including mid- and small-cap insurers, to also take reserve clean-up action. The sooner the commercial space addresses the unclear trends of recent accident years, the sooner we can move on to figuring out the true rate adequacy of those years. Additionally, commercial pricing has remained strong, albeit declining steadily, as seen in Travelers’ domestic business insurance (ex-national accounts) numbers.
There have been questions surrounding rate change, and if the industry does take reserve adjustments, the upside could be a continuation of favorable pricing actions in this space. Beyond the adjustments lies the bigger question of reserve releases likely declining, as discussed in our estimate of industry reserve redundancies.
Firstly, as shown in the note below, the contribution to earnings from reserve releases for Travelers and the rest of the space from commercial insurance will show a declining trend from here. Carriers with multi-pronged operations, including personal lines, could benefit from homeowners’ and auto releases. However, these benefits will be smaller and short-lived.
Secondly, initial IBNR as a percentage of total reserves in general liability has trended up, but for many carriers, it’s not that far from the prior nine-year average. Travelers’ gap was on the narrower side, while WR Berkley, Nationwide and Markel’s gaps have widened. This could be simplistically interpreted as being better reserved, but we would caution against that assessment since classes, books, and geographical focus are different for each company.
Another way to think about this shift in IBNR is to revisit the soft-market years of the 1990s and compare them with the industry’s corrective action. Our analysis shows that the IBNR gap between the 1990s and early 2000s was 13pts, vs. the current gap between the soft market years of 2015-19 to 2020-23 of only 6 pts. So, we would not be surprised to see continued adjustments over 2024.
These points are discussed below:
Long-tailed reserve releases have benefited Travelers in recent years, but will slow down
Travelers’ Q1 2024 results included no net reserve development for the business insurance segment and healthy releases from personal lines and bond specialty. The table below shows the quarterly progression, and one can see the contribution from business insurance and other segments.
Another way to consider the commercial lines releases is to look at annual development by segment, and we can see workers’ compensation offsetting other liability adverse development for several years.
Taking a step back, we can see the gap narrowing between releases from workers’ comp and adverse in other liability. If adverse development in other liability picks up, and if market conditions come under pressure, in theory, net favorable development should continue to decline.
Current level of IBNR as a percentage of reserves shows potential for future development from recent years
At a fundamental level, conservatism in setting IBNR levels can translate into better results and positive future development. The flip side of being extremely conservative is lower reported earnings for that period, as the company sets aside a greater portion for future liabilities.
On its conference call, Travelers noted that it had revisited its recent year’s IBNR level and had made small adjustments. The chart below shows IBNR as a percentage of general liability's total reserves, and the gap between 2023 and the nine years prior to it. Note that WR Berkley, Nationwide, and Markel stand out as having the biggest gaps.
On the conference call, management pointed out that the overall adjustment was minimal compared with overall reserves in business insurance of $41bn. We agree, but it’s always worth revisiting the soft market trends of the 1990s. Prior to that, data consistency issues begin to crop up.
The chart below shows initial IBNR levels for the industry during the tail end of the soft market years and the subsequent corrective action in the mid-2000s. Unfortunately, the gap at that time was nearly 13pts vs. the current gap of 6pts. The pessimist in us worries that loss cost inflation and wage and medical inflation could put pressure on recent accident years’ IBNR levels and leave room for further deterioration.
In summary, although Travelers' results reflect modest corrective action in recent accident years vs. the prior industry action of adjusting soft-market years, it sets the stage for others to pursue similar corrective actions.
Recent IBNR levels for the industry did trend up vs. the soft market years but are lower than the gap following the soft market years in the 1990s, translating into the possibility of additional deterioration.