Insurance Profitability Estimates Deteriorate If the Reserves Established Are Not Adequate to Cover Claims
As noted earlier, one set of our profitability estimates assumed that the industry-established reserves were sufficient to settle future claims. We made this assumption because companies review their reserve estimates at least annually and are bound by state regulators to provide for fully adequate reserves. Future events, however, may show that the reserves are either excessive or inadequate.
Some in the industry believe that the reserves are inadequate. If, due to unforeseen circumstances, the undiscounted reserves r roved insufficient, then the profitability of the lines would deteriorate. To provide a degree of conservatism in light of this possibility, we prepared another set of profitability estimates on the alternative assumptions that the estimated reserve requirements are inadequate to the extent of 10 percent or 20 percent of their current stated value.
If the undiscounted reserves needed to be increased by 10 percent, our estimate of the medical malpractice line’s profitability for the 11-year period 1975 through 1985 would decline from a $65-3 million loss to a $1.2 billion loss, and its rate of return as a percentage of premiums earned would decline from a negative 4.6 percent to a negative 8.8 percent. Similarly, the general liability line’s profitability would decline from a $2.0 billion profit to a $783 million profit, and its rate of return would decline from 3.4 percent to 1.3 percent.
If the undiscounted reserves were insufficient and needed to be increased by 20 percent, the estimated profitability of the lines would deteriorate further. The estimated profitability and rate of return on the medical malpractice line would decline from a $653 million loss to a $1.8 billion loss and from a negative 4.6 percent rate of return to a negative 13.0 percent, respectively. Similarly, the estimated profitability and rate of return for the general liability line would decline from a positive $2.0 billion and a positive 3.4 percent to a negative $462 million and a negative 0.8 percent, respectively.
Likewise, if reserves that had been discounted proved to be deficient and an additional 10 percent needed to be added to settle future claims, then our estimate of the medical malpractice line’s profitability and rate of return would decline from a $2.2 billion profit to a $1.9 billion profit and from a 15.3 percent rate of return to a 13.1 percent rate of return. Similarly, the general liability line’s estimated profitability and rate of return would decline from an $8.0 billion profit to a $7.4 billion profit and from a 13.4 percent rate of return to 12.b percent return.
If the discounted reserves needed boosting by 20 percent to be sufficient, then the estimated profitability and rates of return on the medical malpractice and general liability lines would decline further to a $1.6 billion profit and a 10.9 percent return and a $6.7 billion profit and an 11.2 percent return, respectively.