Claim Reserving Patterns Disrupted in Evolving Risk Landscape

The aftermath of the COVID-19 economic downturn is revealing heightened reserve risk challenges for insurers as they disclose their financial results for the fourth quarter and full-year 2023, as outlined in a recent A.M. Best report.

The latest Best's Special Report highlights an evolving risk landscape in the post-pandemic era, marked by increased reserve risk, particularly for long-tail lines of insurance business. A minor shortfall in current reserves can significantly impact policyholders' surplus and a company's financial stability. Accurately projecting a company's future financial health is crucial, with reserve estimations blending both art and 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," explained Christopher Graham, senior industry analyst, industry research and analytics at A.M. Best.

The macroeconomic disruptions during the primary COVID-19 years (2020–2022) caused a pause in the economic and insurance landscape. The report points out that sectors like construction, travel, education, commerce, and work environments underwent significant transformations. This, coupled with governmental mandates, regulatory changes, legal system adjustments, and subsequent shifts in insurance, has disrupted the historical patterns actuaries traditionally rely on for future predictions.

Furthermore, economic inflation surged. While the average annual inflation rate stood at 2.55 percent from 2000 to 2023 and 1.45 percent for 2015 to 2019—years already marked by adverse reserve development—the rate soared to an average of 5.6 percent from 2021 to 2023. Actuaries incorporate inflation estimates as one of many factors to anticipate increases in severity and losses. With these inflation spikes, there's a risk that severity could be underestimated, prompting actuaries to adjust their previous projections.

Several other factors are adding to the pressure on reserve risk.

• Increased punitive damages in class-action lawsuits against large corporations are complicating loss estimates.
• The growth of litigation financing firms, leveraging advanced technology, is distorting payment patterns.
• Widespread chemicals like per- and polyfluoroalkyl substances and microplastics are leading to numerous lawsuits. Additionally, climate-related casualty litigation and mental health concerns linked to technology addiction could pose challenges in general liability, product liability, and cleanup costs.

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