Questionable Loss Reserves: Are Legacy Reinsurance Deals the Answer?

By Russ Banham

Carrier Management magazine

Twenty years ago, an insurance carrier’s use of reinsurance products like loss portfolio transfers and adverse development covers waved a red flag, signaling potential concerns over the company’s loss reserves to pay future claims. While this is no longer the case—the products have become a common capital management tool—a few other flags are unfurling.

One is growing concern over a range of liability losses in the years preceding the COVID pandemic, resulting in billions of dollars in loss reserve charges by insurance carriers and reinsurers to pay these future claims. Another is the combination of social inflation (juries delivering so-called nuclear verdicts), economic inflation and litigation finance to fund lawsuits. An April report by AM Best stated that the growth in litigation funding firms is creating “distortions in payment patterns” contributing to reserve risk pressures.

These trends have hiked up the cost of loss portfolio transfers (LPTs) and adverse development covers (ADCs) to transfer carrier liabilities to traditional reinsurers and private equity-based specialty insurance providers.


According to reinsurance intermediaries brokering such deals, the bid-ask spread has widened. The bid price is the highest price an insurance carrier is comfortable paying to transfer reserves, whereas the ask price is the lowest price the seller will accept.

Aside from social/economic inflation and litigation financing, another factor possibly widening the bid-ask spreads is negative news articles regarding a few specialist providers of LPTs and ADCs. The Bermuda Monetary Authority is reportedly scrutinizing the adequacy of the legacy reserves of R&Q Insurance Holdings; another specialty insurance provider, Darag, is reportedly either up for sale or looking to break up the company (according to reports from Insurance Insider); and specialty provider James River was engaged in litigation against Fleming Intermediate Holdings for failing to honor the acquisition of its casualty reinsurance subsidiary. A month later, the deal closed.

One or more of these varied concerns may be a factor in the decision by previous buyers of LPTs and ADCs like The Hartford and Markel to pass on buying in recent months. Nevertheless, overall demand for the products has not slackened, reinsurance intermediaries, investment banks and portfolio managers commented.

“The discrepancy in bid-ask suggests that providers have concerns over buyers pulling one over on them, trying to convince the reinsurers that their book is not that bad and deserves a market price to unload it,” said Ian Gutterman, a former investment analyst and portfolio manager and founder of Informed Group Inc., an early stage InsurTech. “Whereas the reinsurer sees the pricing at ‘X,’ the seller sees it at one and one-quarter ‘X’ or one and one-half ‘X.’”

At present, five important developments are in play to affect legacy reinsurance:

  • Inadequate casualty loss reserves, particularly for accident years 2016 to 2019, which have not been addressed fully, requiring additional reserve strengthening.
  • Growing concerns over social inflation, economic inflation and litigation financing, increasing the cost of settling and paying these liability claims.
  • A shift in the LPT and ADC markets, as specialist insurance providers effectively compete against traditional players like Berkshire Hathaway, Allianz Re and Munich Re.
  • Possible skepticism over the financial security of specialist providers due to recent lawsuits and heightened regulatory scrutiny.
  • Changing appetites for LPTs and ADCs, due to the bid-ask spread and the complexities involved in such sophisticated transactions.

Reserve Deficiencies

Insurance carriers fund liability claims reserves to pay claims that are either filed by insureds or expected to be filed. The funded amount depends on actuarial analyses of anticipated claims frequency and severity, an effort that involves complicated math and risk modeling. If the projections are inaccurate, the deficiency in the loss reserves can have a material impact on policyholders’ surplus and a carrier’s financial position.

Both insurers and reinsurers have found the need to increase their casualty loss reserves because of projected loss cost trends. While economic inflation plays a role in expected claims severity, the reserve actions are driven largely by concerns over social inflation and litigation financing. “We have a well-funded and aggressive trial bar today, along with a broadly receptive jury pool more likely to rule aggressively in favor of the plaintiff,” said Meyer Shields, managing director at investment bank Keefe, Bruyette & Woods.

Plaintiffs abound. In addition to legacy asbestos and environmental liability losses, more recent litigation involves opioids, child sexual abuse settlements, “forever chemicals” like PFAS (per-and polyfluoroalkyl substances), industrial and military deafness lawsuits, and sports-related head injuries. The AM Best report pointed to other liability lawsuits emanating from microplastics, climate-related casualty litigation and mental health issues related to technology addiction. The broad scope of litigation has the potential to create issues in general liability, product liability and clean-up costs, the rating agency stated.

Claims filed by policyholders for the years 2015 to 2019, a period of soft insurance pricing, resulted in adverse loss reserve development. In response, loss reserves across the casualty insurance sector were strengthened at many but not all carriers to address the adverse development. “Much but not all of the financial hole the industry had dug [in those years] has now been filled,” William Wilt, president of Assured Research, stated in March 2024. (Related article, “P/C Loss Reserve Study: Keep Calm and Carry On“)

Nevertheless, the April AM Best report cited other reserve risk pressures stemming from 2020 to 2022, when COVID produced massive economic, legal, regulatory and workforce dislocations that distorted the historical patterns actuaries depend on to make decisions about the future. The pandemic is a case in point. “COVID played a role in delaying a lot of claims settlements because the courts were closed,” said Shields. “When they reopened, there was a backlog of cases. There is an axiom in the industry that the longer it takes to settle claims, the more expensive they are.”

High inflation is another reserve risk stressor. The average annual inflation rate—2.55 percent from 2000 to 2023—reached 5.6 percent from 2021 to 2023. “Actuaries use inflation estimates as one of many factors to predict increases in severity and losses,” the AM Best report stated. “Given the inflationary spikes, [claims] severity could be underestimated, leading actuaries to raise prior projections.”

Gutterman offered a similar perspective. “Certainly, there are pockets where casualty reserves are dicey—more likely to be bad than good. If investors think the hole is bigger, a [carrier’s] stock will be down, and the ratings agencies will pounce with a downgrade,” he said.

To offset this possibility, AXIS Capital, Markel, Everest Group and Swiss Re strengthened their loss reserves in 2023. In the fourth quarter, AXIS put up $425 million, Markel about $300 million and Everest Group nearly $400 million. The carriers that took reserve charges in Q4 2023 “surprised people as it was not evenly spread across the industry,” said Shields. “Some companies like Cincinnati Financial, Selective and Travelers earlier in 2023 are widely considered high-quality carriers [that] weren’t in trouble but nonetheless took significant reserve charges.” (Editor’s Note: Prior-year reserve boosts for liability lines were partially or entirely offset by workers compensation reserve takedowns when full-year results were reported for Selective and Travelers. Cincinnati Financial had only a very small commercial casualty charge. Selective reported an additional reserve boost in first-quarter 2024.)

In commenting on the recent spate of reserve actions in an interview, Mahesh Mistry, senior director, Analytics, at AM Best, said, “There is a question of how much of this is reserve strengthening or reserve prudency due to good results.”

Legacy Reinsurance

To appease investors and the ratings agencies, many carriers remove reserve liabilities from the balance sheet through LPTs and ADCs. Mistry cited an uptick in the use of the legacy reinsurance products for the years 2017, 2018 and 2019. “This is where reserve strengthening continues to take place,” he said. “Each contract for LPT and ADC is structured individually based on the portfolio, the buyer’s and seller’s interests.”

Several carriers recently opted to de-risk their casualty portfolio reserves by transferring them to traditional reinsurers and specialty insurance providers. Closed transactions include QBE Insurance Group’s $1.9 billion LPT with specialist provider Enstar, SiriusPoint’s $1.3 billion LPT with specialist provider Compre and AIG’s $400 million ADC, also with Enstar.

However, previous buyers of legacy reinsurance products like Markel, The Hartford and AXIS passed on the opportunity, while James River decided to sell its casualty reinsurance division. Markel’s CFO in its Q4 2023 earnings conference call simply stated that the company did not buy the products, whereas a transcript of The Hartford’s Q4 2023 earnings conference call suggests the cost of the products was an issue.

Shields said estimations of AXIS’s reserve charge of $400 million suggests that the company had “enough capital to maintain a solid rating.” AXIS “did an appropriate job of considering all their alternatives and chose what was the best of available outcomes,” he added.

Demand remains strong for legacy reinsurance, but supply has fallen back from the all-time highs in 2022 to 2023. “At the turn of this decade, a lot of capital flew into the space from private equity,” said Ed Hochberg, head of global risk solutions at reinsurance intermediary Guy Carpenter. “Lately, there has been some retrenchment, due to the same reasons causing concerns over reserving inadequacies like social inflation, resulting in more conservative views.”

Traditional legacy reinsurance markets also have pulled back, Hochberg said. “They’ve become very selective in the types of retroactive transactions they would normally entertain. I think the retrenchment is largely a function of the fact that they already have large blocks of casualty reserves from their regular prospective reinsurance businesses, which have had challenges in recent years from social and economic inflation.”

Barry Gale, global head of Legacy at Aon, said the inclination for transactions among traditional legacy reinsurers is less than that of the specialty insurance providers. “We tend to see stricter underwriting appetites with more limited flexibility,” he said.

Supply and Demand

The restraint in supply is colliding with continuing demand, despite a few carriers opting not to buy recently. Gale attributed ongoing interest to “a desire to generate earnings stability and effective capital management,” adding that the products support operational objectives at a price the buyer believes is commercially attractive.

That price, insofar as the bid-ask spread, is higher due to the aforementioned combination of economic inflation, social inflation and litigation financing. “All things being equal,” said Hochberg, “the cost of capital has gone up as a function of the higher interest rate environment. This is not limited to reinsurance, of course. Something that cost $5 now costs $6.”

Asked about the pricing of recent transactions, Mistry said they vary. “Some can be for a certain number of years or certain class or conditions. They’re quite bespoke,” he explained. “We look at them on a case-by-case basis.” His colleague Tim Prince, director, analytics at AM Best, said, “The pricing of the deal tells us a lot, as it suggests how risky the reinsurer thinks the deal is to reinsure a book of reserves.”

Gutterman offered his own take on the matter. “Carriers try to convince the reinsurers that the book [of reserves] is not that bad, whereas providers worry the carrier may be desperate to get the reserves off the books, snookering them into overpaying,” he explained.

In choosing a reinsurer partner, Shields said the main difference between the big legacy reinsurers and the private equity-backed players is size. “Munich Re and Swiss Re are huge, and Berkshire Re is also very big, although it is more opportunistic and hence probably less relationship-focused than the biggest European reinsurers,” he explained.

Asked if size matters, he replied, “I think it does; all else equal, there’s more security in a bigger balance sheet. Also, Munich, Swiss and Berkshire distribute some of their reinsurance directly to cedents without a reinsurance broker, which certainly allows for more contract customization.”

Gale said the specialist providers of legacy reinsurance are beginning to obtain ratings, making them more directly comparable to traditional rated reinsurers. “Where that is not the case, the security structures in place on these deals—strong and secure collateral requirements as an example—generally mean that cedants can get comfortable with the absence of a rating, albeit in some parts of the world there is a still bias toward rated paper,” he added.

The transactions typically receive the attention of a carrier’s CFO and CRO, in addition to board-level review. “It’s a big decision to make; these are big contracts,” said Mistry. “We expect companies to tell us in advance what they’re planning to do. We then look at how [the transaction] affects the company from a capital perspective.”

Prince concurred. “Typically, we want to know the counterparty’s credit risk, as the transactions can be quite risky. That said, they’re just another risk management tool.”

A Capital Management Tool

His point underscores the wide acceptance of legacy reinsurance. Gone are the days when the purchase of the products signaled concerns over a carrier’s financial condition, an “admission” of brewing problems.

“Carriers look at these products differently than they did 20 years ago, seeing it as a much more formulaic way of quantifying capital [by] reducing the reserving risk,” said Hochberg.

Gale agreed with this perspective. “They’re definitely a much more accepted product to buy for the purposes of effective capital management, not just an accepted but an expected part of reserve and capital management,” he said. “We no longer see the use of the products as an admission of distress but as responsible behavior…by very large and financially secure organizations.”

Mistry commented that the products are widely embraced as a capital management tool to manage capital requirements and P&L volatility. LPTs can be used not only to mitigate an insurer’s risk but also when a carrier wants to exit a market or line of business, he explained, adding that both ADCs and LPTs can help strengthen an insurer’s balance sheet, benefitting the carrier’s credit or financial strength ratings.

“The insurer benefits from paying the reinsurer to administer and pay claims because the liabilities have been removed from its balance sheet,” he said. “An effective LPT/ADC cover will likely have a positive impact on Best’s Capital Adequacy Ratio, making the transaction beneficial for risk-adjusted capitalization.”

The wider use of the products is partly attributable to the work performed by the reinsurance intermediaries. Much time is consumed to structure the sophisticated transactions, which rely on granular actuarial information and analyses, said Hochberg. “Some deals, for example, may include claims servicing, reinsurance administration, commutation agreements and recapture provisions,” he explained. “We don’t just flip a switch and let it happen; we have to shepherd the process.”

As for the future, Gutterman believes reserves remain in inadequate in spite of charges taken in 2023, given the varied and pernicious claims likely to stir the emotions of a jury. “Historically, the industry isn’t great at addressing these things on their first try. Odds are there will be some more pain to come.”

As it comes, legacy reinsurance, despite its present flux and foment, remains a possible cure.

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