The difference between the reserve carried at the previous closing and the now estimated cost of the same claims, the most direct indicator of whether past reserving was honest.
At every closing, the cost of claims incurred before the start of the year is re-estimated. If the estimate falls, the released surplus is favorable development and flows to income; if it rises, the top-up is adverse development and flows to expense. Prior-year development is therefore a grade handed out after the fact to last year's actuaries and claims handlers, and its sign has to be read across several years before concluding anything. Large recurring favorable development is not good news: it reveals conservative reserving that tied up capital and smoothed earnings, which supervisors treat as a hidden reserve. Recurring adverse development signals structural under-reserving, which allowed flattering combined ratios and rates set too low. Under both IFRS 17 and Solvency II, prior-year development is presented separately from current-year results, precisely so that one cannot quietly fund the other.
The US liability market booked adverse prior-year development for several consecutive years starting in 2023, driven by social inflation on accident years 2016 through 2019, with several large groups announcing reserve strengthenings of hundreds of millions of dollars on those vintages. Conversely, a property insurer releasing 4% of opening reserves every year for five years is not making money: it had set aside too much.
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