Contents Under Pressure

Several forces are conspiring to change the shape of the Canadian reinsurance marketplace over the next few years. Whether or not these changes will manifest themselves in 2011 is anybody’s guess.

Naturally, there is a wide spectrum of opinion on the fate of the Canadian reinsurance marketplace over the next year. Picture an industry under pressure from a wide variety of forces. These forces include low interest rates; excess capital; regulatory changes anticipated to shrink capital positions; market consolidation that will make primary insurers’ balance sheets bigger, thus decreasing the need for purchasing reinsurance; a continued shift away from the purchase of proportional or pro rata treaties, with the emphasis instead being on the purchase of comparatively less lucrative excess of loss reinsurance cover; and increased pressure on soft pricing because of the increased frequency and severity of claims related to Ontario auto, D&O and weather-related catastrophes (to name a few).

Will all of these factors, taken together, be enough to squeeze the juice of a hard market out of the fruit of Canada’s current soft market? Canadian Underwriter sought out some educated guesses about what the future might hold. Specifically, we sought the opinions of Canadian reinsurance company CEOs, presidents and chief agents, asking them to answer the following question: “What do you think will be the biggest change in the Canadian reinsurance market in 2011?” Their answers are presented below, in alphabetical order by last name.

1 Herv Castella, Head of Canadian Operations, PartnerRe

Canadian Underwriter’s November 2009 cover story used a cartoon analogy to describe a reinsurance market that was in a state of motionless suspension — but at a tipping point of continued decline. The situation is similar one year later, with no big change in the marketplace. We still face a challenging environment without complete clarity of how it will end.

There is a downward pressure on all profitability drivers, interest rates, exposure growth, loss trends, reinsurance rates, expenses and regulatory capital. Canada is in fact a reflection of the state of the global reinsurance industry.

The Canadian non-life reinsurance market has been shrinking for several years. This reduction is driven in part by the move from proportional to non-proportional cessions, and by consolidation in the primary sector that is likely to continue after a pause of a few years. This will not only affect top line opportunities, but may dampen pressure for price increases even in lines in which such increases are needed to address inadequate profitability.

We have certainly seen some sizeable catastrophes and man-made disasters both in Canada and worldwide, including the record-setting Calgary, Alberta hailstorm in July 2010. But these can generally be described as earnings events rather than capital depletion ones. Although they might lead to modified pricing assumptions in specific segments, we cannot expect these losses to trigger a reinsurance market hardening.

The reform of auto insurance in Ontario will have little to no effect on the reinsurance market. Claims trends will continue unabated for large losses affecting reinsurance programs; the frequency of catastrophic claims may potentially increase. The moderate rate increases in the primary market will not be sufficient to cover the trends.

The effect of increased regulatory demands should not be underestimated either. Capital requirements for the industry are likely to go up and compliance requirements will become an increasingly expensive proposition.

In this context, is the industry in a phase of levitation preceding the free fall as in the cartoon analogy? I definitely do not think so. Profitability will be low but relatively okay in the current return environment. Also, the reinsurance industry is paying increased attention to return on capital and risk management, which should prevent further softening of the market. Nevertheless the industry should not wait for the next big event to return to better profitability. Instead, it should focus on technical underwriting and gradually improve terms so that it is not faced with more serious problems in a few years time when claims costs may outpace revenues.

2 Andr Fredette, Senior Vice President, General Manager, CCR-Canada

Opposing forces are at play in the marketplace.

On the one hand, underwriting results for reinsurers have not been as buoyant in the past two years as they appear.

On an underwriting year basis, they have suffered from the soft rates in the marketplace, both for primary and reinsurance companies, and are probably in a loss position. The low interest rates on investments have not helped either. These results for the last two underwriting years have been masked by the takedown in incurred but not reported (IBNR) from former years during the hard market. Thus there is pressure to increase rates in order to improve results.

On the other hand, we see two factors reducing the amount of reinsurance available. We see mergers and acquisitions of medium size companies by larger companies. Inevitably the larger company has greater retention ability and less reinsurance will be placed after the purchase or merger.

The recovery of the market since 2008 also means primary insurance companies have a stronger capital base to take on more risk. However, growth in a mature market like Canada is difficult with the current competition and low rates. As a result, more companies are taking back the pro rata treaties they placed in former years back into their net retention. This gives them top line growth on their net premium. This loss of pro rata treaty capacity may be somewhat compensated by purchase of higher levels of per-risk and catastrophe treaties. However, the amount of the premium for the excess treaties will be much less than was placed with the pro rata treaties.

The competing and contradictory forces of both soft rates and market consolidation will put greater pressure on the reinsurance market. Whether this leads to higher rates or even withdrawal of some markets is still hard to say. It may also lead to more of the same conditions for another year. Managing this part of the cycle will be a big challenge to all reinsurers.

3 Kenneth B. Irvin, President, CEO, Munich Reinsurance Company of Canada

There is much activity on the Canadian insurance/ reinsurance landscape these days, none of which will individually cause a sea change in market behaviour, but all of which contribute to an evolving and sustainable business model.

The effect of the repeal of reinsurance regulations restricting unlicensed reinsurance to 25%, and overall reinsurance to 75%, of gross premiums will be muted, since less than a handful of primary companies actually approach that limitation in practice for risk transfer purposes. It may open the door to more intra-group capital management activities, by moving monies to more tax-efficient domiciles, but that will just create an Obama-like headache for the Canada Revenue Agency, not OSFI.

There is an abundance of capital in the marketplace, too much for adequate return On Equity. New Primary Commercial Writers have descended upon the market, chasing already underpriced business. Expense monitoring is a big buzz right now, as if cutting costs will somehow improve the loss ratio.

But the one driver that will shift us into a higher gear is the interest rate environment. When the long-term implications of scant investment returns really, truly hit home, we will have no alternative to running our core business better.

4 Henry Klecan Jr., President, CEO–The Americas SCOR Reinsurance Company

Canadian Underwriter’s question about potential market changes assumes a credible crystal ball. I wish I had one. Unfortunately, my crystal ball has been overwhelmed trying to predict with some measure of accuracy the outcome of the var ious initiatives currently making global headlines.

Reinsurance is a global business often subject to macro socio-economic factors. The biggest change in 2011 may be the ability of our industry to adapt quickly and effectively absorb future shocks.

In Phase 1 of the global economy in turmoil, 2007-08, our industry faced a financial and economic meltdown in the context of a global recession, a liquidity crisis, low interest rates combined with exploding credit spreads and fiscal and social deficits that required the emergency intervention of governments.

In Phase 2, 2009-10, we face key uncertainties in a stochastic world, be they in the shape of the recovery, monetary policies, interest rates, exchange rates, sovereign debt and/or tax and regulatory debates.

What will Phase 3, 2011, bring us?

Our industry has shown an incredible resilience. Of course, some members of the reinsurance fraternity have been negatively affected by these macro factors. Nonetheless, we remain strong. But we need to remain vigilant as we face the next wave of uncertainties. How do we identify them, quantify them? Can our organizations absorb the shock and continue providing value to our clients and stakeholders? Can we prevent and hedge ourselves against these uncertainties?

Buckle-up for continued turbulence.

5 Sharon Ludlow, President, CEO, Swiss Re in Canada

The (re)insurance market is operating in a very challenging environment driven by low interest rates, weak underwriting results in certain lines and excess capital in the market. A significant change in the market is likely only if there is a catalyst; and that means either a natural catastrophe or another dislocation in the financial markets. The Canadian market has suffered record frequency in events recently, with relatively little impact on the overall financial stability in the industry.

The impact of proposed and pending regulatory change should not be underestimated. Although the convergence of accounting, regulatory and capital standards worldwide should ultimately be beneficial, a long journey of debate and compromise must be undertaken before this will be achieved. Solvency II in Europe will significantly alter companies’ balance sheets and capital positions, which can present both challenges and opportunities for (re)insurers.

Reinsurance can be a powerful risk and capital management tool. In Canada, the proposed accounting and capital standards would have a significant impact. Year 2011 is a time for the industry to continue to shape and influence these future regimes.

6 Cam MacDonald, Senior Vice President, Transatlantic Reinsurance Company

Several issues may affect the Canadian reinsurance market in 2011, not the least of which is the proposed elimination of the 25% limit on unregistered reinsurance. If regulatory changes proceed as planned, primary companies will have the ability to potentially secure unlimited amounts of unregistered reinsurance, thereby removing existing premium from the Canadian reinsurance market. Couple this with an increase in merger and acquisition activity, a trend towards purchasing excess-of-loss covers and a continued soft market and undoubtedly the premium pie for Canadian reinsurers will continue to dwindle.

Additionally, weather-related events such as the recent Calgary hailstorm are making a big impact on property catastrophe reinsurance programs. On a go-forward basis, the frequency and severity of these storms cannot be underestimated. Clearly current market dynamics have added another layer of pressure on rates for most if not all lines of business. Despite an abundance of available capacity, it is critical to maintain proper technical terms and conditions if we are to achieve any measure of success.

The many challenges ahead for Canadian reinsurers are daunting indeed. It is only through sound management and adherence to basic underwriting principles and practices that we will emerge from these troubling times.

7 Lambert Morvan, Senior Vice President, Chief Agent, Odyssey America Re

Reinsurers’ challenges for the next reinsurance renewal are somewhat similar to those encountered last year. They include a continued struggle to: maintain the pricing discipline on accounts that have good loss experience; address the situation on accounts with challenging loss activity; react where necessary to the increased frequency of weather-related losses; and keep a close eye on the loss cost trends in the auto and casualty business.

However, I believe a longer-term challenge for reinsurers in Canada is how to deal with the steadily decreasing use of reinsurance by insurers. Insurers have enjoyed a large increase in capital in recent years and are now struggling to find profitable growth opportunities. As a result, some insurers have increased their retentions in order to reduce the amount spent on reinsurance, hoping that the bottom line will not suffer. This trend is troubling because of the perception that the purchase of reinsurance is a cost in an insurer’s operating budget. Long gone are the days when insurers materially relied on reinsurers’ capacity to achieve their underwriting goals.

Growth opportunities are limited in a mature insurance market. If you combine this fact with continued consolidation in the primary insurance industry, these two factors accentuate the importance for reinsurers to provide a better business value proposition to insurers. Otherwise, in the absence of any significant loss that would impair the insurers’ capital base, the reinsurance premium pie will continue to shrink.

8 G.S. (Steve) Smith, President, CEO, Farm Mutual Reinsurance Plan

As we close in on the end of 2010, the forecast for the reinsurance market and results in 2011 is a highly speculative one. From the perspective of the reinsurance community, two issues — loss severity and lack of investment income — will likely be the primary catalyst to market change during the next 12 to 18 months.

Recent reforms to the Ontario auto product have not addressed severity concerns; at the same time, primary auto rates are under pressure to remain constant. In addition, storm severity and frequency are driving unprecedented large loss numbers and catastrophe activity on residential business. When considering the lack of investment income, the expectation would be to see applied pressure on underwriting profitability and improving ROE. This pressure will undoubtedly come from shareholders and foreign parent companies as they struggle with commitments and expectations of these stakeholders. It is highly unlikely the primary market will move quickly towards pricing correction, so pricing pressure could quite likely be reinsurer-driven.

This expectation, however, may well be delayed or mitigated due to the continued excess capital in the market and companies wanting to maintain market share and fully deploy capital. In the absence of a specific market-changing event or catastrophe, the change may be slow to materialize.

9 Matthew Spensieri, Vice President, Reinsurance, Catlin Canada

The biggest change I see happening in the Canadian reinsurance market in 2011 is a major move by cedents from brokers to direct reinsurers. Just kidding. But now that I have your attention, let’s continue.

Although there is continuous and constant change in the market, it will not occur suddenly, and it will not appear as any ‘big’ change at all.

The Canadian market in a general sense continues to contract, mostly due to continuing consolidation. The most recent evidence is the announced purchase of GCAN by RSA. The deal has not yet been finalized, but the expectation is for GCAN’s current reinsurance purchases to all but disappear from the market as they are combined into RSA’s existing program.

The expectation of a competitive market will mostly translate into renewal ‘as is.’ The lack of further rate reductions is a result of pressure from reinsurers to achieve minimum and adequate returns for the growin g volatility of the risks they assume. Reinsurers have been demonstrating greater discipline against putting that risk on the books if target levels of return are not achieved. Some covers will likely see increases due to poor experience but also because of this ‘discipline factor.’ One reinsurer made this observation recently with respect to the Chilean market.

Growing retentions for this year are expected to cause increased activity or interest in aggregate retention covers, underlying layers or ‘carve out’ layers. This will be a means of transferring some of the volatility to reinsurers, while helping to control costs.

Lastly, the relative stability of the insurance market in Canada will continue to attract new entrants in 2011. To stay competitive, reinsurers will need to examine or modify their structure, process and model. Not a ‘big’ change really, just change, even on a personal level.

10 Brian Udolph, Senior Vice President, Regional Manager (Canada) XL Re

Both reinsurance and insurance market asset bases continue to strengthen, pressuring companies to employ their excess capital through mergers and acquisitions, buying back their shares or writing additional business and thereby further softening the market. The recent purchase of a large commercial insurer is a good example of this, with more consolidation expected to continue into 2011. M&A activity and switches from proportional to non-proportional reinsurance structures all have the effect of inhibiting growth of the Canadian reinsurance market. With plenty of reinsurance capacity available, it will challenge the market to maintain discipline in accounting for the increasing exposure trends.

The current underwriting year will be extremely challenging for Canadian reinsurers due to the increased frequency of catastrophic losses; greater exposure to large per-risk events; spiraling long-term attendant care costs; and an increasing number of D&O lawsuits filed as a result of Bill 168 and Ontario court decisions, which have furthered the current trend of favouring plaintiffs. Changes to the Ontario automobile product implemented on Sept. 1, 2010 are not expected to bring any meaningful relief to excess reinsurers: all of the reforms are intended to reduce the frequency and magnitude of small losses. The question of whether or not all of this will be enough for the market to show restraint in 2011 remains unanswered.