One concern that I have is that the company appears to be under-provisioning relative to actual claims (net of reserves). Last year was the first year since 1996 (as far back as I was able to look) where the company’s provisions were less than actual claims. I had hoped that this was an outlier and that the company’s provisions would once again increase relative to actual claims. So far, 2011 doesn’t appear to show the desired rebound, so we’ll have to keep an eye on this. Luckily the company has a large loss reserve relative to actual claims.
A reader emailed to express his thoughts about comparing provisions relative to claims. Specifically, he said this is like comparing apples to oranges, in that provisions are for future years, and claims are related to past provisions. I completely agree with this, though my reasoning for comparing the two is as follows:
Though provisions are for future years, it would be unsustainable for an insurance company to continuously make provisions less than actual claims. Eventually the reserves would run out (or regulators would step in!). In ITIC’s case, provisions have consistently exceeded actual claims, so the reserve has grown, which I like. Last year and 1Q 2011 appear to differ from the company’s historical performance in that claims have exceeded provisions, so I made a point of it on my site only to raise a potential issue to keep an eye on – if this is the start of a trend, then I would definitely be concerned as the reserve depletes and the company becomes riskier. All else equal, I like to see insurance companies consistently making provisions that exceed claims, as a long track record of this signifies to me that management is more likely acting conservatively (though, with insurance it is notoriously difficult to tell if the company mispricing long-dated tail risk).
The reader suggested a better way of looking at insurance companies, specifically focusing on the size of reserves relative to claims. I graphed this for ITIC, looking at reserves relative to the trailing year’s claims, as well as relative to the 3-year trailing average claims:
The company appears to be improving after the recession, which is a good sign.
Author Disclosure: Long ITIC