AM Best, the global credit rating agency, says casualty reinsurance is becoming a growing strategic concern for traditional reinsurers as record levels of capital meet uncertainty over long-term loss trends.
In its report, Global Reinsurance at an Inflection Point: Can Discipline Survive the Temptation of Record Capital?, AM Best notes that casualty reinsurance presents a different challenge from property catastrophe business because the market is harder to classify as either hard or soft.
Losses can emerge over many years, while changes in litigation, legal environments and economic conditions can alter the development of claims from earlier accident years.
For AM Best, one of the key questions for casualty reinsurers is whether recent rate increases are keeping pace with underlying loss costs. The answer remains unsettled across the market.
AM Best says some market participants believe casualty pricing remains adequate, with rate increases broadly reflecting higher loss costs and the uncertainty created by social inflation, litigation funding, larger jury awards and changing legal environments. These participants often identify 2019 as an important turning point in casualty underwriting conditions.
Others, however, remain concerned that adverse loss trends are proving more persistent than initially expected and that rate increases may ultimately prove insufficient. AM Best points to differences among reinsurers in their treatment of casualty reserves, with some having reported adverse development in earlier accident years while others have maintained their loss assumptions. Even where more recent loss picks have not been adjusted, AM Best notes that reinsurers are not yet treating the latest accident years as settled.
That uncertainty is influencing how traditional reinsurers approach growth. According to AM Best, some continue to pursue opportunities in casualty, using improved rates to increase group premium and revenue, while others are taking a more cautious approach through tighter underwriting, selective portfolio changes or additional reserve strengthening.
The issue is particularly significant for traditional reinsurers because casualty liabilities can take years to develop. AM Best says the decisions being made today may not be fully understood until well into the next decade, making pricing and reserving discipline important well beyond the current underwriting cycle.
Investment conditions add another layer of uncertainty. A substantial part of the economics of casualty reinsurance comes from investment income earned between the receipt of premium and the payment of claims. AM Best therefore highlights investment market volatility as an additional consideration for reinsurers assessing the attractiveness of long-tail casualty business.
The agency also identifies the emerging casualty insurance-linked securities market as an area to watch. Although investor interest is increasing, AM Best says casualty ILS remains a relatively small part of the alternative capital market, despite discussion of its potential for more than a decade.
AM Best contrasts the development of casualty ILS with property catastrophe ILS, where investors have benefited from characteristics such as relatively short loss emergence periods, event-driven claims and established modelling frameworks. Those features are more difficult to reproduce in casualty business, where liabilities can take years to emerge and ultimate losses can be affected by changes in legal and social conditions.
As a result, AM Best says the expansion of casualty ILS will depend in part on whether new structures can address the uncertainty surrounding long-tail liabilities. The agency also notes concerns raised by some traditional reinsurers about whether investors fully understand the risks being transferred, particularly where structures combine uncertain claims development with investment exposure.
Those concerns are not universal, with AM Best recognising that some casualty ILS transactions involve experienced participants and conservative investment strategies. Nevertheless, the agency says individual transactions that are poorly structured can affect perceptions of the wider asset class.
For traditional reinsurers, the wider issue is therefore not simply whether alternative capital can enter casualty, but whether capital providers can maintain an appropriate understanding of the risks and their duration. With capital plentiful across the reinsurance market, AM Best’s analysis suggests that casualty may provide one of the clearest tests of whether underwriting discipline can be maintained when there are strong incentives to deploy capacity.
The distinction from property catastrophe business is important. While property pricing can respond relatively quickly to changes in losses and capital supply, casualty underwriting decisions can take considerably longer to reveal whether they were appropriate. For AM Best, that makes the preservation of pricing and reserving discipline in casualty reinsurance a key consideration for the market as it adjusts to its high-capital environment.
