Ian Clark examines why the motor market is becoming wary about reserve releases.
With reserve releases in the motor market at an all-time high, you might think there is little good news to come on the reserving front. However, in my opinion, the tank has not yet run dry on motor market reserve releases.
The motor market results have been benign for the past six years, with the net operating ratio at a market level varying between 101% and 102%. Or, as my actuarial colleagues call it, “under cruise control”.
However, such results hide a multitude of sins and, in particular, a level of reserve releases that in 2007 amounted to 12.4% of net earned premium. This is an almost straight line increase over the past five years from a small deficit in 2002.
At a market level, the gap between the “headline” operating ratio of 102.2% in 2007 and the 2007 pure operating ratio of 114.6% shows clearly the significant impact that reserve releases have had on the 2007 results for the UK motor market. Now everyone is asking whether this can continue or whether the 2008 results will show a material decline with nothing left to release.
The key to answering this question is understanding whether at some time in the recent past there has been a change in the basis of reserving at an industry level that led the market to take a more cautious stance.
On the face of it, there is clear evidence to suggest there has been such a change. The consolidation that took place among the largest insurers has brought greater discipline, as has the FSA’s risk-based capital regime. Both these moves are more than enough to support the view that a different and more consistent approach is now being taken.
In 2007, reserve releases from the FSA-registered motor insurers were in the region of £1.05bn with much of this coming from the 2002-2005 accident years. In percentage terms, the highest level of reserve releases came from the commercial book and, for both commercial and personal lines business, was set against a background of improving claims frequency and better than feared severity trends over the past seven years.
However, despite this level of reserve releases, the IBNR (claims incurred but not reported) carried by the FSA-regulated motor insurers has stayed pretty much the same at £2.3bn in 2006 and £2.2bn in 2007. In addition, most of the releases to date have come from the accident years up to 2004, suggesting that there may be further releases to come from the 2005 to 2007 years as motor insurers get more comfortable with their reserving as time passes.
Having said all this, the level of reserve releases in 2007 at 12.4% of net earned premium looks to be unsustainable. But what is clear is the market is still well reserved. This reflects the fact that insurers get penalised by analysts and rating agencies for showing volatility in their results. There appears to be plenty left in the bank to continue to smooth bottom-line results.
Continuing reserve releases in the motor market are therefore here to stay, so let’s get used to it and recognise that prudence as opposed to mischief is the driving rationale.