Just the Surface…?

With most insurers and reinsurers having completed their second-quarter financial returns, there is a general air of optimism within industry ranks that the “worst is behind” as price firming action taken over the past 12 months begins to filter through to the income-statement’s bottom-line. However, many companies are still experiencing the “sins of the past”, but on a different level – the balance-sheet.

After several years of consistent under-pricing, resulting in bottom-line losses or reduced profitability, the North American insurance industry’s reserving has taken a heavy beating, say financial rating agencies. The extent of the problem has already been revealed to some extent in the U.S., following a number of highly-publicized poor results reported by some companies. Notably, in many of these cases, adverse reserve developments have played a major role in undermining current financial performance, with insurers/reinsurers posting significant capital reserve allocations – specifically to shore up for past year’s asbestosis and environmental casualty exposures.

Analysts and rating agencies note that insurers/reinsurers had been under-reserving through much of the late 1990s, and now the price is being paid. Most recently, the St. Paul Cos. reported a consolidated net loss of US$223 million for the second quarter of this year, largely as a result of a US$380 million reserve allocation for settlement of asbestos/environmental claims. This led rating agency Standard & Poor’s to drop its rating of the group from “A-minus” to “B-plus”. Munich Re also announced a capital injection of about US$2.5 billion for its troubled American Re operation, with much of this amount dedicated to asbestos/environmental exposures resulting from the 1997-2001 accident years. Both Munich Re and American Re have retained their “A-plus” financial ratings. General Electric Co.’s GE Global Insurance Group and Employers Re Corp. have also had their capital reserves shored up by the parent. A.M. Best notes that the insurance group experienced an adverse loss development for 2001 of about US$1 billion. The rating agency has maintained its “A++” rating for both GE Global and Employers Re. On a global level, both the Gerling and Axa groups have indicated a desire to withdraw from the reinsurance business, with the former hoping to find a buyer before next year’s renewals are entered into. Standard & Poor’s has subsequently reduced Gerling Globale Ruck’s (GGR) rating from “A-plus” to “A-minus”. In both cases, the companies acknowledge that reserves on the reinsurance side will have to be boosted further than the sizeable allocations already made this and last year.

The Canadian marketplace has also seen some shakeups. A windup order was recently issued for Markham General – which mostly wrote personal auto business in Ontario. The court closure of the company followed after the insurer announced cancellation of policies in June, thereby leaving about $80 million in premium “out on the street”. The Financial Services Commission of Ontario (FSCO) concluded that Markham had insufficient capital reserves to meet its existing liabilities. The White Mountains group implemented a senior management shakeup at its Canadian Folksamerica Re Co. operation, sparking industry speculation that the local branch may not be around for much longer. Munich Re is also expected to restructure its American Re Canadian operation by September of this year. The company’s primarily “specialty risks” portfolio of about $32 million in annual premiums will be handled in terms of underwriting and marketing from the U.S. American Re will likely maintain a skeleton administrative office in Canada. In both cases, the actions taken appear to be driven by spiraling losses and presumably increased pressure on reserves. What many within the industry are asking, “is this just the tip of the iceberg?” Will the poor results and possibly vulnerable balance-sheets of some reinsurers ultimately show similar disease within the ranks of the primary companies? How many financial casualties, or withdrawals, from the marketplace will there be? Being primarily a “branch” marketplace, it is extremely difficult to gauge the financial performance of Canadian operations, and therefore the answer to the above questions.

But, just as importantly as the “cost of the past” catching up with insurers/reinsurers, there is also the concern of future exposures. Notably, the Canadian market has been relatively “cat free” over recent years, and escaped much of the burden of asbestos and environmental losses that have, and continue to take a heavy toll on U.S. insurers. However, the potential asbestos casualty exposure that currently exists in Canada is far greater than the attention the risk has received, observes Swiss Reinsurance Co. Canada’s president Brian Gray. He is particularly concerned with the exposure that exists at the primary company level, and what action is being taken to mitigate this risk.

These are indeed hazardous times, CEOs within primary and reinsurance company ranks note. While the Canadian marketplace will continue to be driven by global company actions, there is increased attention being turned to local experiences – which ultimately may result in a lot more management shakeups and potential branch closures.