The 2019 annual statement of NORCAL Mutual Insurance Co. reveals the extent to which the medical professional liability insurer built its reserve position ahead of inking an agreement to sell to ProAssurance Corp. in a sponsored demutualization.
Development of incurred net losses and defense-and-cost-containment expenses, or DCCE, for prior accident years totaled $146.2 million, or 19.7% of year-end 2018 policyholders' surplus at the lead company of the NORCAL group. The spike in incurred losses led NORCAL Mutual to post a net underwriting loss of $263.9 million as compared with a loss of $8.6 million in 2018.
The resulting net loss of $210.9 million led to a $171.7 million year-over-year decline in NORCAL Mutual's surplus on a stand-alone basis. The reported amount of $570.7 million at year-end 2019 marked a 23.1% decline from the same point in 2018.
Between 1992 and 2018, NORCAL Mutual had only once reported net adverse prior-year reserve development of any amount. Its unfavorable development of $29.8 million in 2017 represented 4.2% of prior-year-end surplus. Its previous largest net underwriting loss was $35 million in 1997.
Comparing disclosures in NORCAL Mutual's 2019 annual statement and third-quarter 2019 quarterly statement finds that approximately $116.2 million of the adverse prior-year development was recorded in the fourth quarter, as the company booked a net underwriting loss of $191.6 million for that period. Although NORCAL Mutual has produced net underwriting losses 47 times in the 76 quarters dating back to the start of 2001, the fourth-quarter 2019 result was far larger than that associated with any single period during that stretch.
Prior to the company's third-quarter 2019 net underwriting loss of $46 million, its largest quarterly loss had amounted to $21.1 million in the third quarter of 2003.
S&P Global Market Intelligence calculates that NORCAL Mutual's combined ratio (with other underwriting expenses measured as a percentage of net premiums written) spiked to 175.6% in 2019, including a loss and loss adjustment expense ratio of 144.6%, from results of 102.5% and 75.7%, respectively, in 2018. The company's loss and LAE ratio last exceeded 100% in 1999, and its combined ratio from 1996 through 2018 peaked at 133.5% in 1996.
The relative magnitude of the unfavorable development in 2019 approached the "unusual" value of more than 20% of prior-year surplus as defined by the National Association of Insurance Commissioners' Insurance Regulatory Information Systems, or IRIS, ratios. Because the decline in surplus totaled more than 10%, it triggered two unusual IRIS ratio values: one pertaining to the gross change and the other related to the change in surplus as adjusted for any changes in surplus notes and capital or surplus paid-in.
ProAssurance agreed to acquire the NORCAL group for upfront consideration of $450 million. The seller would be eligible to receive an additional $150 million in contingent consideration resulting from favorable development of reserves through 2023 relative to the acquirer's expectations for accident years 2020 and prior.
NORCAL Mutual's adverse development pertained to accident years 2015 through 2018 in the medical professional liability-claims made line, according to disclosures on Schedule P, Part 2 of its annual statement. Pre-2015 development on that line was favorable in a net amount of $3.7 million.
ProAssurance President and CEO Ned Rand, speaking during a February conference call, characterized his company's due diligence on the NORCAL group's reserve position as having been "very thorough" and the product of "well over a year" of work by both internal and external experts. Executives noted that reserve strengthening conducted by the NORCAL group in the fourth quarter of 2019 was "in no way reflective of any input from ProAssurance," and was based on what the seller's management thought to be prudent.
"NORCAL has been very forthcoming and open about the information that it has provided to us, and so that gives us a great deal of comfort," Rand said. He added that discussions with NORCAL began in the spring of 2018.
A ProAssurance spokesman declined to further comment.
Sections of the NORCAL Mutual annual statement that might provide additional color on the nature of the adverse reserve development, such as the management's discussion and analysis and statement of actuarial opinion, were not available as of this article's date of publication.