Expect the Unexpected

Global catastrophes of epic proportions dominated headlines all over the world in 2011. Now that the year is almost over, Canadian Underwriter asked senior executives of Canadian reinsurance companies to reflect on the lessons they have learned during this especially tough year, and how they might apply what they learned going forward into 2012.The lessons ranged widely. Some saw the need for further refinement of catastrophe models. Others questioned whether reinsurers had made the most of a strategy to diversify their risks across the globe. Many cited the need for increased underwriting discipline, noting the increased frequency and severity of insured losses in 2011 was exacerbated by the financial instability of the global economy. A few summed it all up in a single phrase: Expect the unexpected. With that, we present the reinsurers’ answers to our question: ‘What lesson(s) have you learned over the past year that you will be bringing with you into 2012?’ The answers are printed in alphabetical order by last names.

1. Hervé Castella Head of Canadian Operations, PartnerRe

The year 2011 saw a series of significant catastrophes both in Canada and worldwide. In particular, the New Zealand and Japan earthquakes brought renewed respect for the very same remote catastrophe risk that threatens Canada.

First, these events have highlighted the large modeling uncertainty around earthquake risk, since their magnitude and impact – e.g. through liquefaction- fell outside of the current science and cat models.

Second, the recent earthquakes demonstrate the challenge of trying to mitigate tail risk through diversification. With only a handful of real peak earthquake zones around the world, each priced to long return periods, you need to look to other lines of business to diversify; even that becomes challenging as client retentions continue to increase. This lack of diversifying risks is particularly pronounced in Canada, where the premium ceded to reinsurers fell to roughly $1.7 billion in 2011, while British Columbia quake limit bought through local catastrophe and per-risk programs reached an all-time high of $18 billion.

Finally, the industry needs to ask itself if it has properly addressed aftershocks both from an accumulation standpoint and a pricing perspective.

In our view, all these factors point to a price strengthening of property reinsurance at a time when the primary commercial market is still flush with excess capacity and competition.

2. André Fredette Senior Vice President, Caisse Centrale de Réassurance

Over the past year, we have seen an insurance market that continues to be stagnant in commercial lines. Some slight improvement in personal lines pricing has occurred. Auto claims seem to have stabilized for now.

An increase in the number of surety claims may be due to government stimulus spending starting to end.

The most prominent factor to date is that reinsurers have seen a significant increase in both the frequency and cost of property catastrophe claims. Large individual fire losses have been the next most significant factor.

We see gradual increases in claims reserves, indicating a kind of inflation factor occurring in the background or, in some instances, a weak reserving policy.

The frequency and cost of catastrophe losses experienced in the last two years may now be the new normal. Unfortunately, pricing has not yet caught up with the claims. Many reinsurers are running combined ratios over 100% at third quarter. Aggregate cat covers have been particularly hard hit.

Large residential fires like Slave Lake will again bring into question the amount of exposure insurance companies assume when putting unlimited Guaranteed Replacement Cost in their homeowner policies. It will probably be two years before we know the true cost of Slave Lake.

The above results, along with a difficult investment climate, will put pressure on pricing in 2012. Given that most companies are in a comparatively rich capital position, it will be interesting to see which companies maintain current covers when prices go up and which will instead move to larger net retentions.

3. Caroline KaneSenior VP, Chief Agent in Canada,Toa Reinsurance Company of America

One key lesson learned in 2011 is that we should expect the unexpected.  Global catastrophe activity, both with respect to the frequency and magnitude of the events, will be remembered for many years to come. Canada, too, has had its fair share of loss activity during 2011. The forest fires in Slave Lake, Alberta, which caused Canada’s second-largest insured disaster, reminded the industry about the importance of insuring to value and guaranteed replacement cost.

We saw an increase in the number of buyers and sellers of catastrophe aggregate covers in 2011. No doubt this trend will continue in 2012, subject of course to adequate pricing for reinsurers’ capacity (given the fact that some of these covers took a beating this year).

For reinsurers, another lesson learned is that it is becoming increasingly important to understand the business models and risk exposures of each of our ceding companies in order to offer practical solutions and fair pricing. We are fortunate enough to have a talented, creative and professional reinsurance broking community in Canada that plays a key role in assisting in this regard. Due diligence is crucial on both sides. Insurers should be evaluating their reinsurance partners more closely and vice versa. We need to take a measured approach in deploying our capital, managing risk and selecting business partners where there is an appropriate strategic fit.

4. Henry Klecan Jr. President, CEO,The Americas, SCOR

Lesson 1: Stay the course

We strive for consistency and continuity in our business approach, thereby minimizing uncertainty. Our clients have appreciated this approach over time and we don’t intend to change this approach anytime soon. Predictability is a key successful factor for us.

Lesson 2: Expect the unexpected

Tornadoes, hurricanes, floods and destructive fires destroying an entire town have made 2011 a year to be remembered. We have seen concentrated severity mixed with some frequency factors. Is there more to come in 2012? How does one underwrite in such an environment? Prepare for the unexpected.

Lesson 3: Underwriting integrity

We have seen a lot of movement in the primary market (insurer) sector to protect or gain market share at almost any cost. This disturbing trend has the potential for a long-term negative effect. Investment yields are poor and we can’t look into that bucket to supplement poor pricing. Where do we go from here? To cite an overworked concept, “back to basics.” Let’s assume a more disciplined approach to our business.

Lesson 4: Economic woes

Canada has been spared many of the economic meltdowns recently experienced in Europe and the United States. We should consider ourselves very fortunate. However, at the risk of being accused of political grandstanding, it is sad to see political agendas superseding or usurping the priorities and needs of citizens. We operate in a global economy and, notwithstanding a strong Canadian regulatory framework, Canadians remain at risk of facing economic turbulence if partisan politics are not checked. Within such a scenario, we continue to practice our profession, be it underwriter or intermediary. I’m optimistic about the business prospects for 2012. What about you?

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

Events of the past few years have given us textbook examples of global interdependence. Whether it was the financial crisis and its domino effect o n banking, or the tragedy in Japan that disrupted supply chains, we have certainly been exposed to a number of hard lessons with their consequences.  As soon as we think we have the last crisis figured out, there’s a new one, and this time the dynamics are far different.

We know about low growth and low interest rates. When insurable assets and financial assets are stagnant or retreating, insurers worry about their bread and butter: premium and investment income.

The difference this time is a stiff political headwind. The debt crisis in Europe is a tough one to figure. One stock analyst said: “We’re used to evaluating companies, economies, industries. Now we’re being forced to evaluate politics. That’s a very uneasy proposition for most investors because it’s not what our background is.”And don’t look to governments to develop “friendly” policies for our sector, since they have more pressing issues to address.

The threat of a second recession is everyone’s problem. We are all interconnected. Yet, being global is also an advantage for reinsurers and insurers. There’s strength in our diversification. Let’s use that to our advantage. Remember that technical underwriting and risk selection are our core strengths. We are a resilient industry in unsettling times.

6. Cam MacDonaldVice President,Transatlantic Re

There can be no denying the frequency of large (cats) and small (kittens) losses produced by Mother Nature is on the rise both locally (Slave Lake, Goderich) and around the globe (Japan, New Zealand etc.). These dramatic increases in large losses, many of the catastrophic variety, are having a significant negative impact on the industry’s loss and expense ratios. What is being denied, and what underwriters should take with them into 2012, is the concept of a large loss load or cat load included in their rate making process. Current rating practices barely address attritional losses, with little or no forethought given to the impact of these large losses on a company’s combined ratio. As an industry, we must address this lapse in our rating philosophy if we hope to gain control of deteriorating loss ratios.

While global economic issues dominate international headlines, here at home we are constantly reminded that Canada weathered the financial crises better than most industrialized countries. Be that as it may, as move throughout 2012 and beyond, it is imperative that we continue to focus on capital management, investment policies and ERM practices, all in an effort to ensure the future financial health of our industry. Having the proper resources in place to manage these critical issues cannot be overlooked. Many organizations have appointed a chief risk officer or similar position to address our ever-changing risk environment. Political risk, economic risk and regulatory risk are but a few of the ERM challenges facing our industry as we move through the second decade of the new millennium.

7. Lambert MorvanSenior Vice President,Chief Agent, Odyssey America Re

A typical question everyone should ask after facing adversity is: What lesson have you learned and what are you doing about it? As far as reinsurers in Canada are concerned, likely the most significant lesson learned is to be aware of the “unknown” when evaluating potential exposure to losses in a reinsurance contract. The Canadian insurance industry incurred significant losses over the past 14 years as a result of what would have been unforeseen catastrophic events. These include the 1998 ice storm, which is still the largest catastrophic loss in Canada, the 2003 forest fire in Kelowna that cost the industry roughly $300 million, as well as this year’s forest fire in Slave Lake, which will likely be the second-largest catastrophic loss for the industry. This should be a wake-up call to insurers and reinsurers. We need to continue to enhance our risk management and risk quantification techniques to go beyond the currently available off-the-shelf catastrophe models. I find it encouraging that the insurance industry generally embraces the use of catastrophe models to manage property aggregate exposures and to quantify the risk transferred to reinsurers. But we must not forget these models have an incomplete set of events from which they simulate probable losses; they do not capture the full array of potential risks or perils that we face in Canada. With three major “un-modeled” catastrophe events in the last 14 years, it begs the question as to how frequent should we expect those surprises to occur? Certainly more frequently than every 50 years.

8. Steve SmithPresident, CEO,Farm Mutual Reinsurance Plan

This year presented several opportunities to experience and learn. It was year of extraordinary losses, globally and domestically, and unprecedented investment market volatility. The year created an awareness of generational differences in the workforce; and it was year that turned the industry focus to underwriting profit and discipline.

The lessons were multifaceted, including lessons of consistency, commitment to core values, commitment to fundamentals, as well as commitments to face change and adaptability.

Following the financial crisis of 2008, discipline and policy came under the microscope. Implementation of sound fundamentals emerged and corrections took place. As 2011 unfolded, these fundamentals and principals were put to the extreme test. Companies that maintained their discipline mitigated the losses from weather events and the market volatility. Risk management policies that identified risk, risk appetite and tolerance, as well as risk mitigation strategies, became essential to navigating the onslaught of adversity. Long-term views needed to prevail, since reaction-generating, short-term remedies would compromise the integrity of future stability and profitability. This compromise to integrity might have threatened distributors’ and consumers’ confidence in their insurers. The integrity of relationships between insurers, distributors and consumers is imperative for ensuring profitable portfolios, proper risk selection and predictable outcomes. Placing values on these business relationships and strategic partners and making them a true priority will outpace difficult cycles, periods or events.

Another lesson arising in 2011 relates to human resources. It became abundantly clear that generational issues and differences were emerging. What motivates young employees is very different from what motivates long-term, experienced employees. The commitment to train, develop and invest in young people is being tested. The “Gen X” and “Gen Y” employees view their employment in an average of five-year increments. As an industry, our commitment to training and development needs to continue to ensure the succession of the future leaders of our industry.

9. Matt SpensieriVice President, Reinsurance,Catlin Canada Inc.

We are all taught from an early age to “learn from experience.” With that in mind, we embrace the 2012 renewal season with lessons learned over the past year.

Catastrophic events began early in 2011 with an earthquake in Chile; an earthquake and tsunami in Japan; earthquakes in New Zealand; and typhoons in Asia. Closer to home, we had hurricanes in the southern United States and Caribbean, and tornadoes in the U.S. Midwest. In Canada, we had flooding, hail, windstorms/tornadoes and the Slave Lake fires.

Just tabulate individual catastrophic losses from around the globe and it becomes clear their frequency is definitely increasing. Cumulative losses from all these various events are also increasing. While 2011 is not yet fully behind us, it is sizing up to be one of the worst years on record – if not the worst – from a catastrophe perspective.

Some of these losses were predicated/predictable. However, in many instances, we are observing that certain exposures may not have been modeled, underwrit ten or priced. In other situations, the magnitude of losses was dramatically undervalued, as in the case of the Japanese tsunami, or return periods were severely understated, as was the case in New Zealand. The important details taken from each event allows all of us to make adjustments to the analytical tools used to manage and price our portfolios. While likely not available for the 2012 renewal season, we should expect to see updated or revised models available from the various vendors, incorporating latest lessons learned.

Lesson learned: models are necessary and wonderful tools, but they are not failsafe, so use accordingly.

10. Brian UdolphSenior Vice President,Regional Manager (Canada), XL Re

There is an old saying, “Don’t look where you fall, but where you slipped.” We learned in 2011 that exposure to catastrophes continues to increase in frequency and severity in Canada and abroad, with the resultant losses eroding reinsurers’ capital bases. This trend is expected to continue and lead to demands to improve exposure modeling and to protect balance sheets from catastrophic events, leading to allocation of aggregate capacity to markets with the highest returns. Class action certifications have increased in Ontario this past year, which may affect loss trends, and this needs to be factored into current underwriting. We view Ontario auto as improving, but it is still an unprofitable product. Despite the acknowledged strength and resiliency of Canadian financial institutions and the reinsurance market throughout the recent worldwide financial crisis, increased regulation and capital requirements will be likely in the near term. All of which could mean reduced profit margins in a low-interest environment. Indeed, we recognize the reinsurance business is becoming more complex and difficult due to increased regulation, the prospect of higher capital ratios, current and short-term low investment yields, combined with the high level of competition. As usual, market response to these difficult challenges ahead remains unpredictable: some lessons are never learned until it is too late.