Reinsurance: Place Your Bets

In last year’s July issue of CU, commentary from various senior managers of reinsurers operating in Canada suggested that the sector would undergo consolidation within the next 12 months. These predictions could have not been more accurate, with the Gerling group having placed its global reinsurance business in runoff (ranked among the top ten within Canada based on premium volume), followed by Terra Nova Insurance, HartRe Canada (with the global group’s US$700 million business having been part-sold to Bermuda-based Endurance Specialty Holdings Ltd.), and most recently, Alea Europe Ltd.’s decision to exit the Canadian marketplace on grounds that its capital could be better utilized in other countries.

Collectively, the above operations represented about $130 million in market capacity for 2002, according to financial data collected by the Reinsurance Research Council (RRC). Notably, with the exception of Gerling Re, the three other withdrawals from Canada each wrote less than $20 million in annual premium, with Alea having reduced its 2000 net written premium of $40 million to around $7 million for 2002. Industry commentators suggest that these withdrawals in the lower premium ranks could indicate a new dynamic in how primary cedents place their business – that being a question to whether the smaller players will be around over the long-term. Size and financial ratings – particularly any changes in financial rating of companies – have therefore become core factors in determining where business goes, which some in the industry argue will see an increased shift in ceded premium to the “true and tested” mega-players.

Not enough

The Canadian reinsurance sector achieved 30%-plus growth in premiums for the second year with assumed premium for the 2002 financial year rising to just under $3 billion, according to RRC member data. This, however, includes only Canadian registered reinsurers, while A.M. Best industry data suggests that the overall Canadian reinsurance market (including business placed with non-registered reinsurers) in terms of ceded premiums amounted to $6 billion for 2002.

While the strong growth in premiums driven by rate increases helped to reduce reinsurers’ combined ratios to an average of 110% for 2002 from the previous year’s 119% average ratio, the ongoing blight with regard to the investment environment – which saw reinsurers’ investment income drop to $316 million for 2002 from the previous year’s $361 million – resulted in a fairly meager 10% year-on-year rise in the sector’s net taxed earnings of $52.9 million for last year. It is also important to note that reinsurers’ returns for 2002 show a 28% reduction in the total underwriting loss to $223 million from the previous year’s $312 million loss which had carried a high cost-tag as a result of the 9/11 terrorist attacks (see chart: Licensed Reinsurers Underwriting Results). The average return on equity of the top ten reinsurance players in Canada for 2002 came in at 4.4%, largely on the back of above average gains made by Everest Re with an ROE of 20.8% and Axa Corp. with an ROE of 13.6% (see chart: Canadian Top Ten NWP 2002). Reinsurer predictions for the 2004 treaty renewals suggest that pricing will be moderate on property and cat covers, although the liability lines will attract higher rates in order to place. Most of the price action taken during 2002 and 2001 focused on property and cat covers, reinsurers note, so adjustments in this area will be tempered (see chart: Cat Property Rate Adjustments).

Although reinsurers in Canada were able to reduce the combined ratio for 2002 by nine percentage points, this is not good enough, says Brian Gray, president of Swiss Reinsurance Co. of Canada. “Particularly since this was not a catastrophe year – we need to be [reinsurers collectively] in the low 90s [combined ratio] in this investment environment to generate appropriate shareholder returns.”

Ken Irvin, president of Munich Reinsurance Canada Group, concurs that a 110% combined ratio is a long way off from where reinsurers should be operating from. And, he notes, the drop in the sector’s combined ratio to 110% for last year from 2001’s 119% ratio largely resulted from the cost impact of the 9/11 terrorist attacks coming off the books of companies. “I think the 110% [combined ratio] was a bad number. I know reinsurers are trying to write at a ratio of below 100% [for this year]. I do feel that 2003 will show a marked improvement in returns. We’re [Munich] targeting a combined ratio in the mid-90s.”

From a general sector perspective, reinsurers in Canada need to attain a combined ratio of around 90% to remain cost effective in the current operating environment, says Pierre Dionne, vice president and chief actuary at CCR. “Which means that a 110% [combined ratio] is not good.” While reinsurers still have some ground to make up in achieving their bottom-line return targets, he believes that the sector will come within a combined ratio of 100% for the current year.

From a global perspective, a report released by rating agency Standard and Poor’s (S&P) notes that, “…the higher premiums flowing into the reinsurance industry are running away through deepening losses on old policies and soured investments”. The sector saw 47 company rating downgrades out of the top 150 reinsurers since the beginning of 2002, the rating agency observes, with only three companies having received rating upgrades. “S&P is indicating that downgrades will still outnumber upgrades [for 2003].”

The S&P report refers to questionable ongoing support of parent owners of reinsurance operations, coupled with the multi-billion dollar adverse reserving adjustments being made by companies on prior year claims as being prime causes undermining the financial ratings of global reinsurers. The rating agency also points to the relative ease to which the new Bermuda “startups” were established after 9/11, which indicates that there are “low barriers” to increased competition in the reinsurance sector. In this respect, of the US$20 billion of new capital having flowed into the reinsurance sector after 9/11, approximately US$8 billion of this amount is accounted for by eight new reinsurers, S&P says. Overall, the rating agency will maintain a negative outlook on the global reinsurance sector based on the above adverse conditions.

Changing game

With four out of 22 members of the RRC having fallen by the market wayside over the past year, the general outlook by primary insurers and brokers is caution with regard to which reinsurance players will still be around in the mid to long-term, commentators say. And, while company withdrawals have created uncertainty, another factor coming into play this year and into 2004 is a new wave of market entrants. At least three post-9/11 startup reinsurers have expressed interest in becoming licensed players in the Canadian marketplace.

Don Smith, a well known figure in the Canadian p&c insurance industry, has been appointed chief agent for Canada of Converium. The Zurich group affiliated reinsurer, which holds about US$2 billion in global capital, gained a license to operate in Canada from the beginning of June this year, Smith confirms. In addition, Smith is also working with Bermuda-based Platinum Re, which is the reinsurance spin-off the St. Paul’s Cos., to gain a license for Canada. The reinsurer holds global capital of about US$1 billion, Smith observes, and hopes to be licensed in Canada before the end of this year. Bermuda-based Endurance also bought up the HartRe’s global book of business, including the Canadian portfolio, and may look to become a licensed local operator.

Smith says both Converium and Platinum, which specialize in catastrophe property and treaty covers, view Canada as a long-term market. “Converium plans in the long-term to be a major player [in Canada]. Although, the reinsurer won’t be writing business for the sake of writing business.” Currently, Platinum through St. Paul’s Marine writes about $20 million in annual premium as a non-licensed Canadian reinsurer, while Converium holds a more modest position as new a non-Canadian registered participant. Both companies hold “A+” financial ratings, Smith adds.

Industry commentators from both the primary insurer and the established reinsurance sectors hold a skeptical to non-committed view to the post-9/11 startups, with many observers doubting the long-term commitment of these new players. Others also fear that these “reserve clean” operators will undermine pricing in pursuit of marketshare, and then clear out when the “going gets tough”. Irvin, however, does not see new entrants to the Canadian marketplace being disruptive. “So far, the new players [post-9/11 startups] have been responsible in not pursuing marketshare regardless of pricing.”

Dionne, on the other hand, believes that the Canadian reinsurance sector is already too fragmented, noting that the recent market withdrawals will hopefully provide more price stability to the marketplace. “I think we’ll see further consolidation globally, and locally [in the reinsurance sector], because of the capital strain on the international players.”

George Cooke, president of The Dominion of Canada General Insurance Co., is a firm believer in “household names”. He notes that, as a ceding company, The Dominion has been dealing with the same reinsurance companies for almost the last 15 years. In this respect, he regards the “established relationship” factor of being a greater priority in selecting treaty participants. “The long-term relationship allows for a ‘meeting of the minds’ on issues in dealing with claims…I doubt we’d be inclined to entertain bringing in a new player [startup company] if we were looking to make a new appointment [to a program].” The Dominion has always maintained relations with the “blue chip” reinsurers, Cooke says, which helps when faced with a hard market and cheap capacity disappears. “When the crunch came with the hard market, we didn’t have to line up like a lot of other companies to get cover.”

Cooke emphasizes, however, the importance of the financial ratings of reinsurers in the risk selection process. The reinsurance broker handling The Dominion’s business presents an analysis of the market each year, Cooke says, after which the insurer then evaluates the financial ratings of the listed reinsurers. He points out, the financial credit worthiness of reinsurers is critical to the operational basis of the insurer. “When the auditors and OSFI [the Office of the Superintendent of Financial Institutions] look at [an insurer’s] statements, they are very interested in the reinsurance recoverable aspect of the risk profile [of the book of business].”

The Citadel General Assurance Co. (Canada) has also dealt with the same core group of reinsurers on its programs for several years, says Roger Keightley, vice president of commercial standard lines and reinsurance. “It’s unlikely we’d look to new players from Bermuda or elsewhere to be lead reinsurers on our programs. We’d want an established track record.”

Keightley notes that the financial ratings of the reinsurers is the first priority for the company. A selection list of reinsurers is determined by the insurer’s Swiss-based parent, according to the appropriate risk rating of the various global carriers, and the local operations of The Citadel are then able to negotiate with these entities in filling their programs, he explains. In this respect, the local selection criteria usually involves participation by some smaller players, but with regard to lead underwriters, the insurer requires that the reinsurer have a local office and also participates in several programs.

Steve Hammond, vice president of underwriting and reinsurance at Royal & SunAlliance Insurance Group, concurs that the single most important factor for ceding companies in selecting reinsurer participation in today’s environment is the financial rating of the various players – specifically the change in their ratings. Another factor is capacity, Hammond notes, the issue being whether companies currently competing for business will still be offering the same in the future. But, Hammond adopts a more even approach to the introduction of the new reinsurance “startups”, suggesting that it would not be all that difficult for fresh players to gain a foothold in the Canadian marketplace, particularly if they were willing to move into the long-tail liability end of the market where there is currently a dearth of capacity mainly on auto liability. “Anyone prepared to get into auto liability will succeed [in gaining business]. New [reinsurance] capacity is needed in Canada. There is definitely opportunity for more registered reinsurers in Canada.”

Smith also feels that the recent withdrawal of players from the Canadian reinsurance marketplace has created opportunity for new entrants. With regard to the “established relationship” bias working against any new players coming in, he notes that the critical side of relationship building lies with the reinsurance brokers. “The [reinsurance] brokers have encouraged the licensing of new carriers in Canada.” And, Smith observes, the real issue in gaining market access is financial rating. “I don’t see any problem [for the new startups] getting into the marketplace with ‘A+’ ratings.”

Big & small

Recent rating downgrades of reinsurers would suggest that being “big or small” holds little sway in market perception. Most recently, French-based SCOR was downgraded by S&P to “BBB+”, while the rating agency placed Employers Reinsurance Corp. on credit watch. Furthermore, A.M. Best has downgraded Employers Re to “A (excellent)” over concern with regard to future capital support by the reinsurer’s parent, General Electric (GE).

But, regardless of rating, primary cedents agree that “size” has come to matter in light of the recent withdrawal of several smaller players. Patrick King, the chief agent of Canadian business for Alea Europe, admits that gaining adequate premium volume based on “good business” became a cost-effective obstacle that ultimately resulted in the global reinsurer withdrawing from Canada. He believes that a reinsurer needs to gain about $30 million in annual ceded premium in order to achieve the necessary risk spread to remain profitable and generate an adequate return. Alea, HartRe and Terra Nova, all of which have ceased writing new business, fell below the $30 million mark. Smith agrees that there has to be a “volume breakeven” for companies to grow. “Pat [King] is absolutely right, you need about $25 million in ceded premium with a [risk] spread to be cost effective.”

In this respect, Gray expects that there will be further consolidation among the ranks of Canadian registered reinsurers. To maintain an infrastructure in Canada and make an economic return, a reinsurer would need to achieve between $10-$15 million in terms of bottom-line. “I think further consolidation in the [Canadian] market is entirely possible. Through the 1980s and 1990s, the [reinsurance] sector built up an infrastructure which cannot be supported by current demand for reinsurance.”