Casualty Reinsurance Renewals See Modest Price Hikes Despite Social Inflation: AM Best

Reinsurers in general maintained adequate capacity for casualty programs, despite concerns about social inflation and some recent reserve strengthening actions, according to a report from AM Best.

For reinsurers, a relatively stable economic environment in 2023, a long run of interest rate hikes, and lower catastrophe losses than in recent years led to ample capacity for the Jan. 1, 2024, renewal season, said the report titled “Despite Heightened Risks, Casualty Reinsurance Renewals See Modest Price Changes.”

AM Best warned that reinsurers, especially casualty reinsurers, may need to be more cautious of systemic risk connected to cyber, emerging risks (such as PFAS, or forever chemicals), and D&O (related to de-SPACs), which could affect multiple insurers, leading to large losses on a reinsurer’s books. (Editor’s note: A de-SPAC transaction is a company merger involving a special purpose acquisition company, a buying entity and a target private business, which carry a higher litigation risk).

The report highlighted the following casualty trends:

• The growing impact of litigation funding on liability awards and settlements is negatively affecting casualty results for primary insurers and reinsurers.
• Both economic and social inflation are adding further pressure on excess reinsurance pricing via worsening claims severity, which has outpaced the increase in prices for a decade.
• With pricing for directors and officers and cyber liability risks moderating following a series of notable pricing increases, reinsurance renewals have returned to normalcy.
• Commercial auto experience remains poor, which is creating reinsurance pricing challenges.

Litigation Funding

Diving into the highlights of the report, AM Best said that third-party litigation funding continues to drive social inflation in the United States where sophisticated plaintiff attorneys’ tactics contribute to inflated judgments.

These strategies include advanced marketing and emotional messaging, the report said.

“Industry estimates suggest that third-party litigation produces an internal rate of return (IRR) of about 25% for the funding entity, which is generally greater than what can be obtained through traditional investments.”

AM Best explained that the practice of litigation funding will continue, driving up loss costs for insurers, if investors consistently are able to achieve such a high level of return, “especially on investments generally uncorrelated to other financial assets.”

Social Inflation and Economic Inflation

Commercial auto, general liability, and directors and officers (D&O) liability insurance “have been notably affected by social inflation over the past decade,” the report said, noting that increased access to information and negative public sentiment toward large companies via social media have contributed to these trends.

“Tort reform has been effective in a number of states with respect to medical professional liability but has been less effective in the case of personal injury. As such there is generally no limit to the economic or non-economic damages that may be recovered by a plaintiff that proves liability, presenting a significant challenge for casualty insurers.”

AM Best explained that loss development patterns implicitly mimic inflation rates, which affect the accuracy of reserves and the pricing of reinsurance agreements. While the rate of inflation has subsided post-COVID, it has not return to the levels of the previous two decades, the report stated.

“With less certainty that prior year reserves are sufficient, price adequacy is also less certain, leading to a larger risk load for parameter risk in pricing,” AM Best said.

AM Best reported that inflation generally has more of an impact on excess than primary layers, “so excess of loss reinsurance is particularly affected by inflation, whether economic or social.”

Commercial Auto

AM Best said that commercial auto experience remains poor, which is creating reinsurance pricing challenges.

“Despite 10 straight years of primary rate increases, primary pricing has been unable to keep pace with loss trends, further pressuring reinsurance pricing.”

Following near-break-even underwriting results in 2021, commercial auto results deteriorated to an underwriting loss in 2022, comparable to the 2016-2019 period, AM Best said. “Commercial auto results through third-quarter 2023 were slightly worse compared with third-quarter 2022, at least on a direct basis.”

Explaining the loss trends hitting commercial auto since the beginning of the COVID-19 pandemic in early 2020, AM Best said poor driving has led to more road fatalities even as the number of total miles driven has dropped.

“Handling smart devices while driving, as well as operating vehicles while stressed or sleep-deprived, has become more commonplace and has contributed to roads being less safe. More severe injuries lead to more claims being litigated, opening the door to third-party litigation funding, which ultimately increases loss severity, as sympathetic juries pile on punitive damages to corporations.”

These increased losses ultimately are leading to higher costs for excess-of-loss reinsurance on individual claims, AM Best said.

AM Best then turned to an analysis of trends in specific lines: D&O, workers’ compensation and cyber – along with the implications of emerging risks, such as PFAS, or “forever chemicals.”

D&O Insurance

While loss frequency has stabilized for D&O insurance, an influx of new primary capital has created supply that now outpaces demand as transactional coverage needs have diminished, the report said.

The impact of social inflation for D&O in recent years “has been muted due to lower frequency; the number of securities class action claims has dropped since the peak 2016-2018 period,” according to AM Best.

“The pendulum has swung quickly to a softening primary market for D&O coverage. Reinsurance rates must go up to offset the inflationary impact on excess layers. For pro rata coverage, ceding commissions were flat to slightly negative at the Jan. 1 renewals.”

Workers’ Compensation

Reinsurers are raising workers’ compensation cover in order to maintain adequate pricing as rates have continued to decline in primary workers’ compensation insurance, AM Best confirmed. “As primary rates decline, reinsurance rates should rise, assuming the primary rate cuts were due solely to competitive pressures and not to declining frequencies or severities.”

The report explained that a flat reinsurance rate on a declining primary premium base results in reinsurers having less money to cover the same risk.

“[A]ny nominal inflation will lead to larger claim payouts. The expected loss to the excess layer is now greater than a year ago, simply adjusting for inflation, so the pure premium for the layer is greater,” the report stated.

Cyber

While pricing on cyber has softened, AM Best said cyber liability results have improved, which has led to a more efficient renewal process.

Reinsurance for cyber remains mostly pro rata, and war exclusions, systemic risk, and loss aggregation remain concerns.”Cyber insurance is the fastest growing line of insurance, and demand will continue to grow, which will in turn flow through to reinsurance demand,” said AM Best noting that there are signs that more capital is flowing into the cyber reinsurance market and excess of loss reinsurance. “In 2023, the first cyber reinsurance catastrophe bonds were issued, as well as the first industry loss warranty bond (the latter issued by Swiss Re).”