Property/casualty insurers continued to take down loss reserves for prior years in 2014, which marked the ninth straight calendar year of favorable development for the industry in aggregate, according to a new report from Fitch Ratings.

Fitch also estimates that the industry reserve position remained adequate overall as of year-end 2014, although the commercial automobile liability and product liability lines showed signs of deficiency, with workers compensation and commercial multiple peril not far behind.

Adding estimates of deficiencies for A&E and other latent liability exposures, there’s a chance of an overall deficiency on the high (most conservative) end of Fitch’s range of estimates—a $5.0 billion deficiency, representing less than 1 percent of overall carried industry reserves. Fitch’s low (least conservative) estimate suggests a $17.6 billion redundancy overall, or 2.9 percent of total carried reserves, even including A&E.

“Chances are limited for near-term reserve deficiencies emerging that would significantly affect capital levels,” said Jim Auden, Fitch Managing Director, in a statement about the Fitch report. “Overall reserve stability is a function of enduring stable loss costs trends. Barring a meaningful upward shift in key loss cost drivers, including general inflation trends, medical expenses and litigation costs, a turn towards reserve deficiencies is unlikely,” Auden said.

Supporting Auden’s remarks on cost trends, the Fitch report cites a figure from Towers Watson—the Towers Watson Claim Cost Index—indicating that composite P/C claims costs increased 2.6 percent annually from 2009 to 2014.

In addition, even though Fitch’s most pessimistic estimates of required industrywide loss reserves indicate a deficiency of 0.8 percent of carried reserves (including the latent exposure analysis), the reserve analysis also includes stress test results at much higher deficiency levels–10 percent and 25 percent deficiencies. While Fitch doesn’t see these stressed scenarios as likely, an analysis of leverage ratios (liability to surplus ratios) concludes that the industry capital position could sustain even these significant levels of deficiency.

Prior-Year Takedowns

Reporting on the continued prior-year takedowns for the ninth calendar year in succession, Fitch notes that the magnitude of favorable development declined only moderately in 2014, and increased slightly through the first nine months of 2015.

For all lines taken together, reserve takedowns for accident years 2013 and prior during calendar-year 2014 shaved roughly 2 points off the calendar-year 2014 industry loss ratio, Fitch reported, using data from SNL Financial for the analysis. During calendar-years 2013 and 2012, the figure was slightly higher—at 2.3 points. The comparable figure was 3.0 points in calendar-year 2011. (These figures exclude the effects of losses emerging from mortgage and credit crisis-related claims in the mortgage and financial guaranty lines.)

More recent underwriting periods may generate future reserve redundancies, Fitch said, adding, however that they are unlikely to generate favorable development at levels consistent with past hard market years—specifically accident years 2005-2007, which now represent a smaller percentage of overall loss reserves.

Breaking Down the Estimates

Fitch’s estimate of overall reserve adequacy as of Dec. 31, 2014 breaks down as follows:

• Accident Years 2005−2014/all lines: $12 billion−$26 billion redundant.
• Asbestos exposures: $5.0 billion−$12.0 billion deficient.
• Environmental losses: $1.4 billion−$3.0 billion deficient.
• Other latent exposures: $2.0 billion−$4.0 billion deficient.

In spite of estimating a core (non-A&E) redundancy for all lines taken together, individually Fitch believes commercial auto liability, workers comp and commercial multiple peril may be slightly deficient—perhaps by as much as 3 percent of total reserves. In addition, the product liability line could be as much as 5 percent deficient (for policies writing on an occurrence basis), the report says.

Providing more insight into line-by-line reserves for accident years 2005-2014, the Fitch report includes charts of paid-to-incurred ratios and IBNR-to-incurred ratios, (incurred-but-not-reported-to incurred losses). For the workers comp line, for example, the IBNR-to-incurred ratio chart reveal higher ratios, or an increasing level of industry conservatism for recent accident years—2012-2014—compared to accident years 2010 and 2011, which developed unfavorably.

For A&E exposures, Fitch estimates reserve deficiencies using a survival ratio approach—(total reserves divided by three-year average paid losses with a target level of between 11x and 14x for asbestos and 8x and 10x for environmental. While the approach is unchanged from prior Fitch reports, it’s notable that the high and low ends of the asbestos deficiency range are each about $4 billion higher than comparable estimates set forth in last year’s Fitch report, which indicated asbestos deficiencies in the range of $1.4 billion−$8.0 billion deficient.

The report notes that higher asbestos loss payments in 2014 drove a carrier reductions in held reserves, correspondingly pushing the average survival ratio down to 8.8x at year-end 2014 from 9.8x at year-end 2013 and 2014—or even farther below Fitch’s target range of 11x-14x.

As for other latent exposures, such as lead paint, nanotechnology, pharmaceuticals and other product exposures, Fitch says its estimate of a $2.0 billion-$4 billion deficiency, while “unscientific,” is based on the belief that the industry does not fare well in its ability to predict new major latent loss exposures—making it likely that prior underwriting years will develop unfavorably.