The global casualty reinsurance market faces mounting pressures from rising litigation costs and higher jury awards, with U.S. reinsurers struggling to keep pace with higher loss cost trends even with rate increases, according to a report from AM Best.

While casualty reinsurance capacity remains plentiful for now, the rating agency says the market’s future depends on the intricate interplay between casualty business, investor sentiment, and market stability.

Social inflation has emerged as a significant force reshaping the casualty reinsurance landscape.

“Social inflation remains a key driver of casualty loss trends on past years and continues to create uncertainty across the casualty landscape amid negative social sentiment,” stated Dan Hofmeister, associate director at AM Best. Social inflation refers to the rising costs of insurance claims, driven by a combination of factors including lawsuit abuse, which includes increased litigation, higher jury awards, and broader interpretations of policy coverage.

The casualty reinsurance market is grappling with several challenges stemming from social inflation. A panel discussion during a recent AM Best briefing on reinsurance renewals indicated that U.S. reinsurers with a casualty reserve portfolio that gain 8%-10% in rate increases are not keeping pace with loss cost trends. The markets that are pushing for 15%-20% rate increases may be the ones that overcome these challenges, according to that discussion.

Legal advertising has played a significant role in fueling social inflation, with such advertising doubling since 2013. This increase in legal marketing has contributed to a more litigious environment, potentially leading to more frequent and costly claims, AM Best observed.

Another factor contributing to the rising costs is the growth of litigation funding. This practice, where third parties finance lawsuits in exchange for a portion of the settlement, is projected to reach a staggering $31 billion by 2028. This trend raises questions about whether rate increases can outpace the loss trends driven by social inflation, AM Best noted.

Investor Preferences and Market Dynamics

Despite the impact of social inflation trends on casualty business, publicly traded reinsurers are incentivized to continue writing casualty business, even at poor margins, to grow their business and optimize the cost of capital, AM Best stated.

Casualty lines have emerged as a favored choice among investors, the report explained. Over the past two decades, reinsurers with higher allocations to casualty lines have experienced a higher average yearly increase in stock prices compared to their property-focused counterparts. Moreover, companies with higher property allocations generally trade at lower price-to-book value multiples, further underscoring investors’ inclination towards casualty-oriented reinsurers.

The appeal of casualty lines extends beyond mere market sentiment, and is rooted in structural advantages that benefit reinsurers’ balance sheets, according to the report.

Casualty business typically results in higher levels of reserves due to the longer duration and relative uncertainty of claims payments. These reserves generate additional investment income before claims are settled, effectively providing reinsurers with interest-free capital, AM Best explained. This unique characteristic of casualty lines allows reinsurers to maintain profitability even in challenging underwriting environments.

The investment appeal of reinsurance casualty lines becomes even more apparent when contrasted with the insurance-linked securities (ILS) market. While the ILS market has experienced significant expansion, focusing almost exclusively on property lines coverage, it struggles to compete with traditional reinsurers in casualty business, according to AM Best.

The long-tailed nature of casualty lines poses challenges for ILS investors, as it can trap capital and lead to uncertain investment horizons. Consequently, investors seeking exposure to casualty business are largely limited to traditional reinsurers, driving up their value as they increase their proportional allocation to casualty lines.

Market Outlook and Challenges

Despite recent adverse reserve developments in the casualty reinsurance sector, the market continues to exhibit abundant capacity, according to AM Best.

“As the January renewal cycle closed, capacity remained abundant and there was no talk of hardening rates or dramatic shifts in terms and conditions. Reinsurers have apparently not had the same sense of urgency they did just a few years ago with property lines,” the report noted.

Looking ahead, the casualty reinsurance market faces several significant challenges. One pressing issue is the emergence of negative margins in certain casualty lines. AM Best’s analysis of developed accident-year loss ratios combined with calendar year expense ratios revealed that some casualty lines had negative margins as far back as 2019.

The ongoing impact of social inflation without meaningful tort reform poses another major concern. “However, reforms are unlikely if reinsurers are willing to write the business,” the report stated. “If insurers are able to purchase reinsurance for their casualty books, they will continue to write high limits. If insurers offer high limits, social inflation will continue to vex the industry until some reform takes place.”

View the full AM Best report here. &