Canadian reinsurers: AT PURGATORY’S GATE

In Dante’s “Divine Comedy”, the author undertakes a spiritual journey that begins with hell, or “inferno”, and ultimately concludes with the paradise of heaven. And, during Dante’s journey through “purgatory”, led by the heavenly guide Virgil, they come to a wall of flame forcing them to tread carefully along a narrow ledge carved into a cliff. At this point, Dante writes, “along the edge where we were forced to walk in single file; and I was terrified – there was the fire, and here I could fall off! ‘In such a place as this,’ my leader [Virgil] said, ‘be sure to keep your eyes straight on the course, for one could slip here easily and fall.'”

Such could be said for the fate of reinsurers. Sticking to the path without falling off could prove trickier than many may think. However, Canadian reinsurers are adamant that 2002 treaty renewal rates will have to rise on average by between 10% to 20% – this follows a hike of 10%-15% which came into effect for covers this year. But, while reinsurance results clearly indicate that further price firming is needed, the temptations of sin that resulted in inadequate pricing remains: market fragmentation.

Faced with ongoing excessive market competition, which is particularly pronounced in Canada, the question remains to whether reinsurers will maintain their resolve when the 2002 treaty negotiations begin around September of this year. The risk of additional premium volume moving out of the traditional insurance market as the pricing cycle firms, remains a real concern. And, of course, the threat that insurers may respond to significant reinsurance rate increases by boosting their own retentions, is another factor for caution (with the large capital glut accumulated by insurers over recent years, retentions were rising even during the soft market cycle).

Although the path ahead is fraught with obstacles, reinsurance CEOs consulted by CU believe that the market dynamics of recent years have changed. Yes, competition remains intense, no one wants to lose business, they say, but the pressure being brought to bear by international head-offices is beginning to bite. The message has gone out that the business had better be profitable, or do not write it.

While last year’s poor results in the global reinsurance market were marked by soaring catastrophic losses (primarily due to several European storms that occurred in late 1999, which pushed the European combined ratio to over 130%) which was further aggravated by escalating retrocession cover prices, this year’s financial returns are almost “cat free” yet the loss ratio has continued to climb, they note. Specifically, Canadian reinsurers escaped any notable catastrophic losses last year, observes Brian Gray, president of Swiss Reinsurance Co. of Canada. Yet, he notes, the sector’s combined ratio for 2000 clocked in at 113% compared with the previous year’s 105% (which was a cat year coming off the 1998 ice storm). “And this [2000 financial returns] was not a cat year, the losses coming through are simply due to years of inadequate pricing that are finally catching up with companies.”

Canadian numbers

According to the Reinsurance Research Council (RRC), Canadian reinsurers ended the 2000 financial year with a 113% combined ratio compared with the 105% recorded for the previous year. Overall, reinsurers came home with a meager 4% ROE.

But, the real telltale of last year’s numbers lies in the sector’s underwriting result, which produced a year-on-year increase in loss of a 160% to reach $173 million. The saving grace for reinsurers lay in investment income, which climbed by nearly 32% to $381.3 million compared with the previous year’s $290 million. This enabled reinsurers to post a modest pre-tax income of $217.5 million for 2000 – down by 13% on 1999’s taxable income of $250.9 million. All of the CEOs CU spoke to were less than optimistic of strong investment performance for the current financial year, hence the increased pressure to rectify the underwriting ratio.

A factor which could come to the aide of reinsurers is the fact that the primary market produced a significant decline in its favorable reserve development for the 2000 financial year, according to Insurance Bureau of Canada (IBC) data. This follows several years of rising reserve margins over expected claims costs (see chart on page 14). Although Canadian insurers managed to maintain a healthy rise in unpaid claim provisions for last year, the feeling within the market is that many insurers will be reluctant to increase their retention exposure against the unexpected rise in losses. While there is always the risk that firming reinsurance prices could create a run by insurers to raise retentions (notably, the market’s response following the reinsurance rate adjustments following Hurricane Andrew and the Northridge Earthquake), the current market conditions do not support such a broad reaction, says Andre Fredette, senior vice president of CCR. “We could see higher retentions from some of the bigger players [insurers], but I think that many might feel that this is not the right environment, not until we see some underwriting improvement.”

“It’s pretty bloody embarrassing stuff,” comments John Phelan, president of Munich Reinsurance Co. of Canada with regard to last year’s dismal financial returns of both the reinsurance and primary insurer sectors. Phelan describes the market’s recent activity as “incompetent”. The numbers will have to improve, he stresses, even if means turning business away. “If this means being a smaller company for a short time, so be it.”

Phelan is confident, however, that Canadian reinsurers and insurers can “turn around” the industry’s under-performance, “but we can’t do that by sitting around waiting for someone else to move”.

Reinsurer perspectives

Although market fragmentation remains a key factor influencing weak rates, Phelan expects reinsurance capacity in Canada will tighten up this year. “It will become more difficult to buy cover,” he predicts. An informal survey conducted by Munich Re of the Canadian reinsurance treaty arrangements that kicked into force from January of this year suggests that rates for the current year rose on average by between 10% to 15%. “This is not good enough,” Phelan observes, the implication being that insurers will likely face even steeper rate adjustments when the treaty negotiations for 2002 begin in the fall – nearly 90% of Canadian reinsurance treaty renewals occur at calendar yearend.

HartRe’s general manager for Canada, Michael Rende says there is no great secret to the sudden plight facing both reinsurers and insurers, this simply comes down to the fact that not enough premium is being collected in relation to the losses arising. “This means premium rate increases. Reinsurers and insurers are all moving in the same direction, but when you’re a buyer [such as an insurer], then there’s always reluctance to pay more, so it’s going to be about finding a balance.”

One obstacle to implementing appropriate pricing last year was the multi-year contracts which became fashionable in the lead-up to Y2K, Rende notes. There were still a number of multi-year agreements in place when this year’s renewal negotiations were entered into, he adds. This is not the case for 2002 renewals, and these programs will likely receive the most attention in the upcoming round of treaty discussions.

Some insurers think reinsurers are taking a “tough stand”, observes Patrick Lacourte, chief Canadian agent for PartnerRe. “We’re not even back to 1993/4 rates, so this isn’t a tough stand.” Reinsurance capacity in the Canadian market remains strong, he adds, “but now, it depends on whether the business is right”. While the recent acquisition by Scor of Sorema’s global operations is indicative of the need for consolidation among reinsurer ranks, Lacourte expects the overall number of players on the Canadian field will likely remain the same. “What has changed is the business philosophy of the underwriters. There is also a sense within the primary market that rates have to rise, and this includes reinsurance ra tes,” he adds, which bodes well for the challenge represented by the pending treaty negotiations.

Lacourte notes, however, that the Canadian insurance market has been slow in reacting to the need for price corrections compared with international markets. Specifically, U.S. reinsurers/insurers have been quicker out of the gate than their Canadian counterparts. “The U.S. has reacted much more so over the past year, whereas Canada normally reacts quicker.”

“The purpose of reinsurance is to smooth out the results of ceding companies, we’re [reinsurers] not a charity or the Facility Association,” remarks David Wilmot, chief agent of Toa Reinsurance Co. of America. His comment refers to the increasing and ongoing rise in general losses within the primary market and a sense of resistance from those within this quarter to reinsurance rate increases. The market is already seeing increased retentions at the primary level, he notes, which will likely rise further as reinsurers bring pressure to bear for rate corrections. “So far the market [Canadian] has seen progressive, but minor [reinsurance] rate increases. The conservative Canadian approach will probably mean that reinsurers will miss the boat on the firming rate cycle. The U.S. market [reinsurance] has already moved by 30% to 40%.”

Wilmot is also not optimistic of a reduction in reinsurance capacity in Canada in the immediate future. No one is likely to buy a reinsurance company in the current market environment, he adds. And, he remarks, “there are still one or two reinsurers in Canada who should check the batteries in their calculators, their pricing remains well below the loss experience.”

Specifically, Wilmot believes the results on excess-of-loss covers for Ontario auto will show marked deterioration this year, “I think the losses emerging will be significantly greater than is currently expected”.

First-quarter insurance returns would definitely seem to suggest that there is ongoing price weakness in the market, says Gray. “There is no question, [financial] returns have to go up.” Gray points out that the combined ratio rose last year, despite the lack of any catastrophic losses. This clearly suggests that rates are inadequate to the loss experience. “It’s hard to forecast what the market might do. I suspect that some reinsurers not previously willing to let business go might be more inclined to do so this year if they can’t get the price right.”

While most reinsurers will likely adopt a careful evaluation approach to pricing this year, with emphasis on rating individual risks relative to loss experience rather than applying a “broad-brush” correction, Gray believes an average 15% rise in rates would not be unrealistic. Some cases, namely multi-year arrangements coming up for renewal, could be subject to a rate hike of up to 30%. Then again, ceding companies with better-than-average loss experiences, could only see a modest 5% increase in rates, he notes. “Certainly, faced with firming reinsurance prices, some insurers will look at higher retentions and other alternative risk solutions. But, generally, I think the rate increases reinsurers are looking for will stick.”

Peter Borst, chief agent for Employers Reinsurance Corp. of Canada (and current chairman of the RRC), concurs that a reduction of reinsurance capacity through consolidation within the marketplace is unlikely. However, he holds the view that the “easy capacity’ of the past will disappear, the change being more of a prudent management approach by reinsurers to writing business. “I don’t think that this is a buyer’s market, the emphasis is definitely on the bottom-line, and not the top-line.”

That said, Borst concedes that “price is not everything”. Primary company retentions are part of the equation, he observes, and the approach reinsurers take to the business does depend on the relationship prospects with each client. “You can’t write programs on price alone.” However, he affirms that reinsurers will be adopting a steely approach to the upcoming treaty renewals. “Proper price will be the emphasis.”

Fredette points out that, “worldwide, these are not happy numbers [reinsurer financial results]. There’s no pressure [among reinsurers] for volume. Reinsurers are now looking for the proper technical result, and Canada will follow in line.” As such, he believes the upcoming treaty renewals could produce a sharper price correction than many within the industry can imagine. “There’s going to be a lot of pressure brought to bear [by reinsurers] in the coming months.”

Furthermore, the impact of reduced retrocession capacity continues to exert pressure on reinsurers at the global level, Fredette says, which will be another driving factor in support for rate increases. Overall, he expects reinsurance rate adjustments of between 10% to 20% for the Canadian market this year. “One treaty I heard had been recently renewed with a 30% [upward] correction. The pressure is on to get the book correct, but these are likely to be a ‘technically correct’ rate adjustments rather than based on relationship.”

U.S. direction

U.S. reinsurance results for the first quarter of this year indicate that the sector is succeeding in curbing its rise in losses, with the combined ratio for the reporting period clocking in at 106.4% against the 112.4% ratio recorded a year prior, according to the Reinsurance Association of America (RAA).

The 30 U.S. reinsurers represented by the RAA results, also increased net premiums year-on-year by 20% to US$6.7 billion compared with the US$5.6 billion reported for the first quarter of 2000. The jump in premiums is attributed to price hardening, while the drop in the loss ratio is believed to be mainly a result of fewer catastrophic events. Standard and Poor’s New York office expects further rate strengthening will take place at the mid-year treaty negotiations, when roughly a third of the renewals occur.

Furthermore, the January 2001 renewals in the U.S. marked the first catastrophic reinsurance price rise in seven years – the last following Hurricane Andrew and the Northridge earthquake – observes Paragon Reinsurance Risk Management Services Inc., which maintains a catastrophic price index of the industry.

Average property rate increases in the U.S. to the end of April this year are running 20% to 25% up, says Marsh Inc. in its latest “Insurance Market Update”. Notably, 15% of insureds renewing in April received increases in excess of 50%, with one quarter of the total attracting between a 25% to 50% rate hike, while another quarter drew increases of around 15% to 25%. About a third of renewals fetched rate increases of less than 15%, according to the report. “Some clients with large catastrophe exposures, or particularly poor loss histories, have been unable to complete all layers. This is especially true at the lower end of programs. The cost to complete this last portion of a program can drive the total cost up considerably since insurers want to minimize their exposure to claims exceeding whatever retention or deductible is in place. In general, retentions and deductibles are trending upward.”