InsuranceIR's Blog

Looming behind the various predictions of a turn in commercial lines pricing at some point in 2011 or 2012 is an “elephant” many companies find hard to discuss – reserve adequacy.

Based on prior insurance market cycles, commercial lines insurers and reinsurers can be expected to report adverse development in the quarters before and after pricing starts to turn.

Wall Street knows that the swing from favorable to adverse development is coming, as several analysts have reaffirmed to me in recent weeks. In the minds of insurance investors, the question isn’t whether there will be a swing to adverse development, it’s when it will happen and which companies will see it first.

Use Strategic Communications to Get Ahead of the Curve

Since the “when” and “which insurers” aren’t known — unless a company sets the stage appropriately – investors are prepared to treat each new report of adverse development as a negative surprise!

And Wall Street doesn’t respond well to these announcements. In one case in the third quarter, a company lost about $200 million in market value in one day when it reported an almost immaterial level of adverse development.

Using strategic (fully disclosed) communications to appropriately manage market expectations may be an insurance company’s only defense against short-term reactions of this sort. (The underlying reality of corporate performance and reserve adequacy is established over multiple years — in the long run, the strategic vision communicated by management must correlate with the reported financials.)

The more expansive year-end communications are one of the best opportunities for insurance company investor relations teams (from the CEO on down) to put information out “ahead of the curve,” to help cushion the surprise.

Practice Ways to Address the Issue with Investors

IR teams can use the potential for adverse development (or the market’s expectation of adverse development) as a reason to sit down with senior management to strategize on key messages. The plan could include:

• Provide investors with the data they need to analyze your company’s loss and reserve trends – by line of business (ideas are in the post “Can We Talk … About Reserves”). Include the concepts and summary data in earnings releases, discuss the topic on conference calls and in presentations and – perhaps most important — give the full details in the 10-K.

• Evaluate your company’s year-end commentary with an eye to how it will sound in three, six or more months (be realistic and appropriately cautious). For example, consider whether this is the right time to be saying that “prior accident-year loss ratios are holding up … .”

• Closely monitor industry and peer group news. Investors will be evaluating your company’s comments in the context of what is being said by other carriers and the brokers, as well as insights from their friends and acquaintances in the industry. Expect questions based on those reports, and be prepared with answers.

• Make sure the channels of communications will remain open before, during and after an announcement of adverse development.

Bottom line, companies that guide investor expectations by delivering (fully disclosed) credible, transparent and principled communications over the long-term are rewarded with higher valuations (see my post “Looking Forward vs. Earnings Guidance” for additional thoughts).

Filed under: Investor Relations |