Another Brick in the Wall…

The year past was marked by the cost pressures of rising claims costs, plummeting investment returns and a steely attitude of global insurance head-offices to the writing of new business. The impact has been profound, from consumers, brokers through to the management of insurance companies.

The effect thus far has been lost markets, vanished capacity, double-digit price increases, a hostile political/regulatory environment, and more than one or two local management shakeups. The market also saw several casualties in wind-up orders and some companies ceasing to write new business. The recent announcement by the Royal & SunAlliance group of a global restructuring and exit from markets in which the insurer has incurred heavy losses, or simply has not gained what it believes to be “critical mass”, is a sign of these turbulent times. Now, in setting the financial stage for 2003, the last shoe is about to drop: the cost of reinsurance.

Whilst bemoaning the generally inhospitable underwriting environment, most primary insurer CEOs I have spoken to recently now talk of the “constricting cost of reinsurance”. No doubt, the pending 2003 reinsurance treaty negotiations are very much on their minds at this time of the year, however, there is also a real sense that reinsurance is going to play a greater role in determining company strategies in the year ahead. Based on commentary from reinsurance CEOs in CU’s annual “Reinsurance Strategy Outlook” (see cover article of this issue for further details), the impact is not only going to be “price”, but restricted terms of coverage. While this year’s treaty renewals were primarily about price, with the negotiations hurried as companies tried to come to terms with the market aftermath of 9/11, reinsurance CEOs say that 2003 treaties will be dealt with comprehensively, with attention turned to conditions of cover and exclusions against emerging exposures such as asbestos and mold.

Which is not to say that pricing won’t be an issue in the pending negotiations. Primary companies can expect double-digit increases for the second year running (with likely more to come in the years ahead), reinsurance CEOs say. Certain classes of business will likely attract upward rate adjustments of 50%-100%, they add. There are also some covers like auto proportional treaties which may be impossible to place. Will the outcome of the 2003 treaties result in some primary insurers pulling out of the Canadian marketplace? Or, perhaps, withdrawing from certain lines of business? Reinsurers definitely expect that, within their own sector, the tightened market conditions will see additional players exit the business – the future of one global reinsurer operating in the Canadian market is currently hanging in the balance.

A significant factor driving both the primary and reinsurance property and casualty insurance sectors is the reduction in capital/surplus. While the impact is more acute on the reinsurance side, the limitations placed on the players will feed down to the primary market in terms of reduced capacity. Estimates suggest that the global reinsurance industry lost about US$180 billion in capital/surplus over the past year, while the inflow of new capital from operators within the London and Bermuda markets over the same time period has been minimal. As such, a capacity shortage will continue to drive reinsurance pricing well into 2004, reinsurer CEOs predict.

The dramatic reduction in available reinsurance capital not only places pressure on pricing and coverage, but presents a new concern factor for primary insurers: the financial soundness of their reinsurer partners. With the financial rating agencies having over the past year downgraded many of the global reinsurance carriers, while some companies have openly admitted that they need to replenish their corporate coffers in order to compete effectively, the question in many primary insurer minds is whether their reinsurers will be able to honor coverage in the event of a claim (needless to say, single-event large cat exposures would be the primary concern). As such, reinsurance CEOs, at least those at the top of the “food chain”, predict that the 2003 treaties will see a marked shift in business to top-tier underwriters.

Reinsurers are not the only players subject to capital constraints. Many primary insurers are facing the same challenge, and as the rating agencies have shown concern, raising capital in the current investment environment may prove extremely difficult. Put simply, capital has become cautious and expensive. Next year will therefore mostly go down in the insurance industry’s history book as the “challenge for capital” – the last brick in the industry wall as the marketplace undergoes its painful but necessary recovery.