In our outlook and Q4 preview, we took a cautious view on continuing releases from workers' compensation.
Once reserve releases for the less mature years are taken down, the only course of action in this uncertain loss climate is to add back when trends worsen. Investors of publicly traded insurance companies and trading partners, rating agencies, and the broader insurance group generally frown upon that course of action.
On the publicly traded side, property casualty insurers also face the added pressure of managing their messaging so as not to surprise investors.
Our prior analysis of litigation continued to reveal an uncertain trajectory over 2023 and 2024. Similarly, CPI-related items have also continued to tick up. The future trajectory of inflation remains unclear as the Fed’s prior path intersects with the priorities of the new Trump administration.
Against that backdrop, this earnings season takes on greater significance. It opened with Travelers reporting on Wednesday. The company reported strong earnings, with the stock up 6.4% at one point, although closing up 3.2% – likely reflecting its close-to-all-time high 2.1x price to tangible book stock multiple, as well as a 30% Q4 return on equity.
From our vantage point, the topic to focus on this quarter was pricing and its implications for the commercial lines cohort. The disclosure shows a slow walkdown from peak rate rises, and we expect to continue to see the same trend from other companies reporting this earnings season.
We also focused on discussing underlying trends. As higher rates are earned and future rate rises continue to increase at a slower pace, this could translate into margin contraction for Travelers and the remainder of the group. Additionally, Travelers' quality of reserving practices and account focus has translated into a higher-quality book.
This has also been validated by our prior reserving work and the lack of large adjustments in Travelers' earnings releases over the past several years. Therefore, what might be true for the company might not be true for every commercial-predominant insurance company.
We also compared the company's reserve buckets to those of the industry group and noted that not all companies will be able to offset adverse development without a well-performing workers' compensation book of business.
We discuss these points in detail below.
Pricing ticked down modestly, implying rate rises might have peaked for the sector
The table below shows the pricing metrics for several insurance companies, along with some of the more relevant pricing surveys. Travelers’ Business Insurance (excluding National Accounts) was up 6.9% for the quarter, down 30 basis points sequentially.
Travelers' pricing data aligns closest with the Willis Commercial Lines Insurance Pricing Survey (CLIPS) pricing data, which makes intuitive sense since that data is derived from actual pricing systems, while the others are surveys.
This implies that overall pricing for the industry will likely decline sequentially as well.
There has been much debate on the future rate trajectory and the various pushes and pulls that make up the overall rate. Some market participants feel that these pushes will make the overall rates rebound from here.
There are lots of puts and takes with different lines operating under their own dynamics, but we believe the base case remains for net range change for Travelers and others to continue to climb down from previous highs.
Underlying combined ratio implies they might be close to their cyclical best as well for the industry
The chart below shows Travelers' underlying combined ratios over time with the Business Insurance pricing (excluding national accounts) overlaid. This was one of its best quarters ever. Could underlying trends improve even further? Perhaps, but we think it is unlikely.
As pricing slowly comes down and loss cost inflation remains unchanged or goes up, in theory, that implies margin contraction. That would translate into an increase in the underlying loss ratio. We don’t expect every company in Q4 to have a sequential improvement in the underlying loss ratio, and expect Travelers to be more an outlier in this regard than the norm.
The chart below shows quarterly reserve development by segment on a GAAP basis. A few things stand out. First, there is an uptick in reserve releases every fourth quarter, which coincides with the yearly reserve review. Second, the highest level of releases is from the Business Insurance segment.
What might be true for Travelers might not necessarily be valid for the rest of the reporters this earnings season. As we discuss in the next point, Travelers' workers' compensation reserves are meaningful and can offset adverse development in general liability.
For this quarter, the company noted that workers' compensation releases were $200mn, offsetting adverse development in other lines to net a $116mn favorable development, as shown below. Since Travelers is a higher-quality business, its releases are not indicative of the rest of the group reporting meaningful favorable development as well.
We would also note that the company disclosed a shift in casualty reinsurance buying patterns this quarter, which allows it to benefit from the reinsurance pricing metrics and which give it added protection if trends worsen from here.
Size and trend of the workers' compensation book will determine insurers’ ability to offset adverse development
The chart below shows workers' compensation and general liability reserves as a proportion of commercial lines reserves.
Two things stand out. First, Travelers has a much larger workers' compensation book compared to general liability. For the industry, the reverse is true with workers' compensation reserves being smaller than general liability reserves.
Second, workers’ reserves for both Travelers and the industry have declined over time due to rate declines over the past several years. Note that a diminishing bucket of reserves translates into a smaller absolute number even if trends remain stable.
The next two charts show how workers' compensation releases have increased for both Travelers and the P&C industry concurrently with rising general liability adverse development over the past 8 calendar years. As discussed above, Travelers’ workers’ compensation releases have more than offset the adverse effects of general liability.
This might not be true for other commercial carriers who have smaller workers' compensation books.
The table below shows the size of the largest players' workers' compensation, general liability, and total commercial lines reserves. It also shows the ratio of workers' compensation reserves to general liability reserves. Our analysis shows that only a few carriers possess higher workers' compensation reserves than general liability reserves.
In summary, we believe that Travelers' trends, although reflective of favorable pricing and loss cost trends, might not be uniformly applicable to the rest of the commercial lines’ insurers. Results will also depend on its own written and earned rate trajectory, views on underlying loss cost trends, and the size of different reserve buckets, which impact the ability of one line to offset adverse development from other lines.
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