North American Insurance Conference: The Perfect Storm

“The insurance industry had a lot of problems before September 11,” admits Bill Star, the president and CEO of Kingsway Financial Services and host of the North American Insurance Conference which was recently held in St. Pete’s Beach, Florida. The impact of the 9/11 events is a change in attitude among insurers and reinsurers, with limited coverage available and rising rates already being witnessed. It is a welcome change, he adds, one that should prompt insurers to set rates adequately and tighten their underwriting guidelines. “At one time, reinsurance was so plentiful, it almost encouraged us [primary insurers] to be irresponsible.”

North of 20

Reinsurance price firming actually began on July 1, 2001, explains Sean Mooney, economist for Guy Carpenter & Company. This was particularly true on the “per risk” side, which saw significant increases in 2001. And, at a time when the underwriting business of commercial lines is growing, reinsurers have been “pulling back” from pro-rata treaties, formerly heavily written at “very expensive commissions”. There has also been a move to quality and consolidation shaping the market. While there were 62 U.S. reinsurers in 1992, by 2000 only 31 remained.

September 11 was a catalyst for the reinsurance market, bringing swift, severe rate increases. In early November, there was still speculation on just how big those increases would be.

For non-catastrophe business, the hikes could be 25%-50%, while for cats, this could jump from anywhere between 25%-100%, suggests Brian Gray, president of Swiss Re Canada. Certainly the increases will be “north of 20%”, agrees Mooney, and prices will not be based on the primary market, but on the need for reinsurers to start generating profits.

And, despite these increases, for some reinsurers it may be a case of too little, too late, for certain severely under-priced business. “There are certainly a number of programs out there where a 25% or 30% rate increase is not going to bring profitability,” remarks Gray.

While Canadian insurers suffered relatively small September 11 losses, they will by no means be spared the brunt of rate hikes, as well as exclusions, notes John Doran, assistant superintendent of the supervision sector at the Office of the Superintendent of Financial Institutions (OSFI).

On the U.S. side, Rex Hahn, vice president of reinsurance broker Holborn Reinsurance, says he has seen increases in the range of 20%-100%, even for small companies with little or no September 11 exposures. And rate increases are certainly not the only issue facing insurers in the reinsurance market. Reinsurers are tightening up signing deadlines, notes Hahn, requiring acceptance of quoted terms in seven to 15 days. “We’re not going to have time to jockey around.” For primary insurers, “for the first time in their lives, they’re calling reinsurers and not getting their calls returned,” observes Mooney.

Capacity crunch

While there will not likely be major insolvencies as a result of September 11, it does beg the question, can the industry withstand another massive catastrophe, notes Hahn.

Certainly there are concerns about capacity following September 11, despite the entrance of new reinsurers, based primarily in Bermuda. This capital is not a reaction to September 11, however, but a response to rising rates, says Mooney. Investment banker Morgan Stanley has estimated that about US$14 billion in new capacity could enter the property and casualty insurance marketplace, while existing companies such as Hartford and ACE have launched capital-raising initiatives. The speakers agree, however, that new capacity will not soften rates. “I’m sure this won’t keep the rates down,” says Tom Gallagher, Florida’s Insurance Commissioner.

“They [new reinsurers] are fairly broad in what they will write and fairly opportunistic, responding to where the rates are,” Mooney adds. Gray also notes that the new capital will not soften this year’s renewals, and is not on the same scale as that which entered the market following Hurricane Andrew.

Exclusions, exclusions

Terrorism exclusions in reinsurance contracts were certainly a predicted result of the attacks on the World Trade Center and Pentagon. “Terrorism [coverage] was given away prior to September 11, it was priced at zero, really,” notes Mooney. Now it is going to be a key underwriting issue.

Hahn adds that he has seen at least eight different levels of exclusions from reinsurers, although some have opted for the “absolute” exclusion, a move he says is “too radical”. “There is no ‘good’ terrorism exclusion at this time”, especially given the requirement for primary insurers to provide this coverage to their clients, he says. As well, insurers may also face environmental exclusions relative to the mould claims under homeowners policies that are starting to mount. “It’s certainly giving the homeowners and contractors general liability markets fits,” Hahn observes.

Large properties may also face a changing reinsurance market, Gray adds. There is increasing demand for large cap items to be taken out of treaties and put on the facultative market.

The question is, will rising reinsurance rates and exclusions push insurers toward higher levels of risk retention? The answer, speakers say, is probably “yes”.

While companies were becoming comfortable with their retention levels prior to 2001, and they had remained at a relatively flat level, Mooney predicts “a lot of things are going to change” in terms of retention. This is coupled with the fact that reinsurers, facing a tightening retrocessional market, had already begun prior to September 11 to say no to certain business. In the face of the tight contract deadlines Hahn speaks of, insurers may take on more retention, “they have the capacity and the hardening rates” to support this move, notes Serge LaPalme, president and CEO of UAB Group. “There is definitely some truth to that,” Gray agrees. After Hurricane Andrew, primary companies certainly took the option of boosting their retention levels. Gray also agrees with Star’s assessment that the industry has been “over-reinsured” in the last few years, with too many small reinsurers in the market, especially given the reduction in the number of potential clients due to primary market consolidation.

Rough year

Even before September 11, reinsurers were “already on target” for a rough year, says Mooney, with cat losses high. Pricing catastrophe risks is still a daunting task, notes Gray, despite reinsurers having spent millions of dollars on risk modeling. “Still nobody has a really good idea of what impact a severe natural catastrophe in an urban area would be.”

Other problems have plagued the industry in recent years. Reinsurers are facing increases in costs, both in terms of severity and long-term tail claims costs, Gray explains. Healthcare costs, such as workers’ compensation in the U.S. and bodily injury in Canada are showing a “tail”, as medical costs outpace the rate of inflation. And the rise of class action lawsuits is creating a new class of severity, including “fair disclosure” suits as they relate to directors and officers exposures.

At the same time, he says, reinsurers are dealing with growing environmental claims, which are making headlines. “Environmental, I’m convinced, will again be a tremendous capital challenge for reinsurers.” For primary insurers, homeowners liability issues, such as environmental claims, are becoming a big issue for insurers, says Mooney. Although homeowners has not been a problem in the Canadian market, U.S. business has seen combined ratios above 103% consistently over the last decade.

Where Canada has lagged the U.S. is in terms of rate increases on auto. As well, mounting claims costs relative to medical/rehabilitation, are hampering Canadian auto insurers, Mooney adds. Loss ratios are not the biggest problem facing insurers, suggests Brian Johnston, president of Markham General Insurance Company. Expense ratios are the issue. Insurers, he says, should be contracting out certain non-core business functions to increase their efficiency. “We’ re supposed to be underwriters, let’s underwrite.”

Overall, the picture is bleak. The Canadian industry is forecasting a return on equity for 2001 of around 2.6-3.5%, and is looking at a 10% increase in claims costs, a 30% drop in investment returns, but only an average 8.6% rate increase, LaPalme explains.

From an investor’s perspective, there is little incentive to put money into insurance stocks, says George Fowlie, partner at National Bank Capital Partners. There is “no momentum” in the p&c sector, as an investor, “you can’t take a ride” like in the tech sector. While insurance stocks are conservative and stable, “it’s much more fun to get involved in some 15-year-old’s idea of what the future should be and his million-dollar dreams. From an investor’s perspective, we see discipline in premium pricing as essential.” Investors are also looking for companies having the discipline to step out of markets if they can not get the right pricing, he adds.

As well, insurers are facing their own investment portfolio woes. “The prospects for investment income are not particularly rosy”, Fowlie observes, which makes it all the more crucial for insurers to get the underwriting business right. Prior to September 11, he adds, “we had the makings for the perfect storm — Hurricane Combined Ratio plus Hurricane Low Rates plus Tropical Storm Crashing Equity Markets”.

The catalyst

September 11, despite its tragic consequences, should signal the turnaround for insurers, speakers agree. And investors are taking notice, Fowlie says. “Equity markets tend to look at these cats as opportunities,” and there is a sense that September 11 will be a catalyst for proper pricing among insurers. “The pricing discipline created by the tragedy should be preserved.” Another positive sign, according to Fowlie, is the seeming acceptance on the part of regulators of the need for rate hikes. While Doran notes that OSFI does not have the authority to address rates, the federal regulator can, through the Canadian Council of Insurance Regulators, impress upon provincial superintendents the need for relaxation of rate suppression. “We [ as regulators] are not happy when you are unprofitable. Profits are the first line of defense for policyholders,” he says.

LaPalme sees the next two to three years as a great opportunity for insurers to get the industry back on a profitable track. September 11 may be a force for positive change in the industry, if insurers are motivated to make the necessary rate increases. “It didn’t start with September 11, but it may end with September 11.”