Reinsurance Strategies 2002: Bargain Days Over

With the global reinsurance industry likely to face a price-tag of around US$35-$40 billion as a result of the September 11 terrorist attacks, many companies have already indicated that 2002 treaty covers will hold terrorism exclusions – a non-negotiable issue.

The potential economic disruption caused by a “reinsurance vacuum” with regard to terrorist-related losses has prompted the U.S. government to appoint a special congressional investigation to determine the establishment of a government-backed reinsurance facility. Many countries, including Canada, are investigating similar mechanisms to maintain the availability of insurance coverage at the primary company level.

Regardless of future government intervention in the North American insurance marketplace, at least in respect to terrorism covers, reinsurers and insurers have for several years struggled with weak market pricing conditions, adverse underwriting developments and waning investment returns. Coming off the back of an almost non-existent industry return on equity for 2000, this year was supposed to have signaled a positive turn in the insurance pricing cycle, but ongoing excess capacity, particularly on the reinsurance front, tempered the extent of actions.

Up until September 11 of this year, reinsurers were hopeful of achieving a 15%-25% general increase in 2002 treaty renewal rates. The current outlook of global reinsurance players is that rate increases of a 100%-plus will be expected on many commercial property covers. The views expressed by reinsurers in CU’s annual “Reinsurance Strategy Outlook” (see below for specific company commentary) clearly suggest “easy capacity” will not be available in the upcoming January treaty renewals. Many expect that proportional, or “pro-rata” programs will not be renewed, but converted to more cost-confinable excess-of-loss arrangements. A number of the CEO’s consulted expect “top-end” cover layers will attract significant price adjustments, while the cost reaction of insurers could see lower-end layers disappear.

The impact of September 11 will likely be far more pronounced on the reinsurance industry than simply affecting pricing, the CEOs note. Most expect a withdrawal of companies from some markets, and potential failures among some of the global players – concerns of which have already prompted insureds, brokers and regulators to place greater emphasis on the financial security rating of companies. As such, price is unlikely to be the single factor determining where insurers place their reinsurance business, a lot more thought is going to be given to the security of recovering reinsurance liabilities, they add.

Patrick King, chief agent of ALEA Canada

My comments for last year’s “Reinsurance Strategies” issue described the unacceptable reinsurance results in Canada and worldwide during the period of 1998 to 2000. I wrote optimistically that the market would firm substantially over the next few years, and that rate increases of 10% to 25% would be achievable on catastrophe and per risk covers in year-one (2001) of the return to sanity. Fortunately, I also described the excess capacity in the market as still being a major factor and a “drag” on the recovery because, frankly, we were disappointed with the price improvements that were achieved for 2001 and continued to be disappointed as the year progressed.

Proportional business is generating losses to reinsurers. Commissions are still unrealistic on programs that continue to produce unsatisfactory loss ratios due to inadequate underlying primary rates. In addition, occurrence limits are too high. Catastrophe and per risk treaties improved somewhat but also remain under priced. Some industry observers maintain that it would take a 200% increase to return rates to 1990 levels!

Alea Canada wrote over $40 million of assumed reinsurance premium in 2000, 75% of which was proportional business. We will finish 2001 with around $16 million because we simply refused to support proportional business with terms and conditions that would not provide us with a reasonable return on equity and we withdrew completely from the facultative market because of the severe under pricing in the primary market. The insurance and reinsurance world has completely changed since September 11, 2001. Insured losses from the World Trade Center (WTC) are expected to run between US$30-$50 billion. If property and casualty insurance losses are US$35 billion, the impact on reinsurers could be as high as US$25 billion. The combined impact is the removal of US$35 billion of capital/surplus from the market in one day. Hurricane Andrew was only US$17.5 billion, or half this amount. In addition, lower investment yields mean insurers no longer have an investment income cushion.

Each reinsurer will have different priorities for the 2002 renewal, but here is a probable shopping list:

Inclusion of the new “data exclusion”/”loss occurrence” clause, and the “ultimate net loss” clause;

Implementation of the revised “pollution/environmental liability” exclusion, and an appropriate “terrorist exclusion” clause;

Reduction of occurrence limits to reasonable levels on both proportional and per risk treaties;

One year deals which allow both parties flexibility to meet changing market conditions;

Strong rate improvements to achieve target ROEs and sufficient margins to begin to restore the capital and surplus loss of this and past years.

Alea has excellent capacity and we want to achieve reasonable growth in 2002, but prefer to provide capacity for those ceding companies interested in a long-term mutual “win-win” relationship as opposed to opportunistic situations based on low rates and soft market terms and conditions.

Andre Fredette, senior vice president of CCR

The Reinsurance market has been heading towards a hardening stance given the dismal results of the last four years. The events of September 11, 2001 have obviously accelerated those tendencies and will also reshape the insurance and reinsurance landscape. In the present future (2002 – renewal season) one can expect the following:

Excess of loss treaties will increase in price 35 to 50%. Exact increases will depend on prior year results with the better treaties being loss affected;

Pro rata treaties will be difficult to place given prior year results. Those that are placed will command significant reduction in commission terms;

Cat capacity will be reduced and more expansive;

The retro market will be significantly reduced, if not totally gone;

The renewal season will be late as companies try to ascertain what retro capacity is available if any. In Europe there is currently paralysis in both the reinsurance and the retro markets;

Strong debate between the Insurance Bureau of Canada and Reinsurance Research Council on the inclusion of terrorism exclusion.

In the near future we can expect to see the following events:

Failure of some retrocessionaires as the cash calls for the WTC loss come in;

Withdrawal of some of the weaker reinsurance companies from certain markets;

Reduction in Lloyd’s capacity and probably restructuring again;

Withdrawal by some companies in commercial property in B.C. due to lack of capacity on cat treaties and resulting in strong increases in B.C. earthquake rates;

Significant rate increases of 50 to 100% in heavy commercial property and tighter terms and wording;

Further consolidation in the insurance and reinsurance market along with some new entrants who will feel the time is ripe to get into the reinsurance market;

Overall a return to underwriting basics and tighter terms over the next three years.

Peter Borst, chief agent for Employers Reinsurance Corp. of Canada

Before the tragedy of September 11, 2001, there was anticipation of a firming in the Canadian reinsurance market for 2002 treaty renewals. The World Trade Center tragedy is forcing additional dramatic change.

At GE Employers Reinsurance Corporation (ERC), sound risk management has allowed us to endure extraordinary events in the past and will ensure that we ove rcome this event.

Our strategy is to focus ERC resources on customers who value what we offer – AAA security and strong underwriting expertise. Our goal is to earn a greater share of our customer’s business by understanding their business, identifying and meeting their critical needs and, of course, providing the best reinsurance security available.

We look for long-term partners that share our values and vision. Our goal is to provide outstanding service and capacity to customers that share our strategic focus. Those businesses will receive priority in terms of service, capacity and the attention of our underwriters. For example, ERC will continue to emphasize liability business where we have strong underwriting capability and enjoy the competitive advantage that our AAA financial ratings bring.

Anticipating a very hectic renewal season this year, we will focus on the most significant opportunities for increasing our share of a program. We will also quickly identify those submissions that do not match our threshold and communicate this to the broker or customer early so they can work with alternative markets.

Much has changed following the catastrophic events of September 11. Insurers and reinsurers must place a priority on protecting their balance sheets. For some, this may mean the difference between remaining solvent or not, for some of the stronger markets this same focus is necessary to maintain strong ratings. After all, financial security and confidence is at the core of what our business is about.

At ERC, we will seek to maintain our focus by working with cedants to ensure terms and conditions properly reflect exposure. Given the dramatic new exposures in the North American market since 9/11, it is possible that PML/EML clauses may be eliminated on treaties. Indications are that total market capacity may very well shrink as some players withdraw.

In addition, most buyers are already anticipating an increase in cost of reinsurance. When you consider the results of the Canadian reinsurance market in recent years (113% Combined Ratio for 2000), corrective actions were already taking place. The tremendous human tragedy of September 11 permanently changed the way we think, act and work. It has forced us to learn serious lessons and make adjustments.

For the insurance and reinsurance business, this is a time for underwriters to get back to the basics, to recognize exposure, assume an appropriate level of risk and charge a price that reflects the risk. It is a time for us to provide the confidence that is the cornerstone of our business.

John Kartechner, president of Gerling Global Reinsurance Co.

For the moment let us consider that the cowardly and despicable acts of September 11th did not take place. How was the reinsurance market performing? If our second quarter figures were indicative of the marketplace, one would have to question whether any changes actually took place at January 1, 2001.

Our message last renewal season was “NPC” – nudge, push and clobber – denoting the actions required depending on client and account. We recognized that “broad-brushing” was not appropriate. We acknowledged that there were differences with respect to individual clients’ performance. We supported the thought that some clients embraced the loyalty concept, that some put the relationship ahead of the most attractive price. To ensure equity, the terms and conditions at January 2001 had to reflect these differences. However, all needed to throw something into the pot. So some gave little (a nudge), the vast majority needed to give more (a push), and a small but troubling group had to cough up considerable concessions to reinsurers (a clobber). Did we believe this was successful last year? Yes, maybe not to the scale we wanted, but we were comfortable with the success. So what happened then? Why are the numbers so poor to date? Well, a big part of the problem seems to be related to the lack of action at the primary level. During the renewal process, clients revealed what they had in store to turn their market around, thus helping to improve our situation. Our pricing was predicated on our clients initiating the required changes. Unfortunately these changes were very slow, and in some cases non-existent. So our slogan this year was slated “NPC: Round 2, Promises Unkept”. Along with another round of rate increases, commission reductions, greater transference to swings and slides, and generally more restrictive terms and conditions, we would insist on a cyber clarification/exclusion. We were ready for the onslaught of submissions.

Then the unimaginable. September 11th opened our eyes to the thought that we really do not understand the full gamut of potential exposures. An evil man, controlling an evil web (and likely controlling a country’s government), orchestrated a hideous crime that will cause the failure of some insurers and reinsurers. Suddenly capacity becomes scarce as reinsurers withdraw and reflect. Insurers and reinsurance intermediaries begin to assess the creditworthiness of their reinsurance partners, presently and down the road. How has this tragic event changed things? Well, certainly the war exclusion will be clarified/broadened to exclude such acts. And rates? Up, way up. Terms and conditions? Tight, real tight. The really sad part is that it took such an incident to push the insurance industry into becoming responsible. This too is tragic.

Roy Vincent of Hannover Re

The horrible events of September 11 have shocked the world. They have at the same time set the stage for the forthcoming treaty renewal season. With much of the loss falling to reinsurers, in excess of 60%, it is clear that the reinsurance industry will need to react to this event.

What does this mean for the Canadian market? While mostly it is not directly involved in this loss, there will be knock on effects from the occurrence. Firstly, it is clear to all that terrorism coverage can no longer be offered under our standard policies and reinsurance contracts. To address this problem we are seeing a number of private and/or government solutions, and in Canada we can look for solutions where our experience in other countries can be of help.

Other issues that we have been struggling with as a market will also need to be tackled and addressed. Cyberspace liability will be one area that we have to act to reduce the exposure that we potentially may have, although the signs are that we are someway down the road with this issue in Canada. Mainly, however it is evident that we can no longer offer coverage at prices that do not offer a fair return for the capital that we put at risk. Let us not forget that the returns for the industry in Canada are already looking pretty abysmal and therefore unless action is taken to adjust rating to adequate levels, particularly in the area of auto and commercial business, then it is doubtful whether reinsurers will be willing to continue to support proportional coverage.

Last but not least, the flight to security that has been evident for the last few years will continue. Bearing in mind that a substantial amount of primary and virtually all reinsurance capacity is provided by non-Canadian entities, the events of September 11 will reduce the number of active players in the market. It is to be noted that this process has already begun. The remaining providers of particularly reinsurance capacity will however not be in a position to write all the business and therefore marginally performing contracts will have difficulty in finding a home. As the storm clouds gather we are reminded of the expression that every cloud has a “silver lining”. Once again we see the chance to discuss with our clients both our needs and how we can move together forwards. In these discussions, Hannover Re can provide more capacity in a leadership role, provided the potential for adequate returns exist. New forms of protections to the market can be discussed but at the end of the day the key message is that we must all return to sensible underwriting.

Robert Ysseldyk, president of Odyssey Reinsurance Co. of Canada

Wh at a difference a day makes. Where many buyers, sellers and intermediaries were pondering through the summer the extent to which the reinsurance market would harden, we may now wonder how far the pendulum will swing. Will there be an over-reaction to the disaster of September 11, or is this the catalyst that will finally push the market in the direction it needed to go?

Most, if not all, Canadian reinsurers are members of global organizations and as such were all impacted by this occurrence. The effect will not be limited to reinsurers alone, however, as primary companies will need to adjust to a coverage landscape changed by terrorism. Where do we go from here? What price adjustments need to be made? What will happen to terms? Will coverage be available at any price? The entire Canadian marketplace will be radically transformed. Higher reinsurance prices and restrictions to terms and conditions will affect most lines of business. The hyper competition that has been part of the reinsurance market is likely to diminish, and perhaps disappear altogether. Capacity will likely be less than at present, or at least re-deployed as reinsurers will be looking to optimize returns through careful management of their catastrophe exposures. There will likely be a move away from proportional to excess of loss coverage where the downside risk can more readily be quantified and contained.

There is a need for reinsurers to earn a fair return on their investment in this country, in order to deliver and maintain the security so much sought after by the reinsurance buyers. Prior to the events of September 11, the reinsurance market was already poised to harden substantially as 2001 was expected to produce the second consecutive year with a combined ratio in excess of 110%. The terrorist attacks have shown the vulnerability of our entire insurance industry to a new and unforeseen danger. We have also subsequently seen that we can withstand the huge financial impact mainly based on the strength of the same reinsurers that operate in the Canadian market. With diminishing returns on invested assets the whole insurance industry will have to rely on underwriting profits in order to show rates of return that warrant shareholders’ support. No longer will reinsurers be eager to participate in poorly performing business unless the reinsurance buyer can demonstrate that the inadequate rating of the past years has been corrected.

Will we enter a harder market going into 2002? No doubt. But, we will still be there for our ceding company partners, we will still be there to help them find the solutions that will make the insurance industry profitable for both parties. It may not be easy this time around, but we believe the resolve is there to make it happen.

Patrick Lacourte, chief agent for PartnerRe

If you were to read the comments of reinsurance company CEO’s appearing in last year’s CU December issue, you might have expected that, after three bad years, the Canadian reinsurance market was about to turn and that shareholders would be rewarded for their patience.

The “miracle” did not happen. Reinsurers, in spite of slightly improved conditions in their favour for 2001, were not doing any better than the primary market in the first half of the year. The loss pattern in Canada continued to stay a step (or two) ahead of premium. The US market was not doing any better.

And then bad came to worse: the “unforeseen” occurred on September 11th. The human drama, if not the financial cost, was almost beyond imagination.

But let’s take a minute to look back at world history. Throughout the ages, the human species has organized itself in order to survive, and to improve its prospects. There have been some setbacks along the way but, in spite of many catastrophes including two world wars, the western world has been able to secure a better life.

The insurance industry has been a key factor spreading the misfortune of a few among the more fortunate.

A case in point is the San Francisco Earthquake in July 1906 that destroyed 28,000 buildings. Insurers and reinsurers didn’t hesitate for a minute and took a very active part in the reconstruction of this devastated city.

The same spirit is driving the insurance industry today to overcome the impact of the tragic events in New York, even if it was not entirely clear whether coverage was affected by “acts of war” language in policies and treaties.

However, securing the future availability and affordability of insurance after these attacks is a must for both the governments and the public. The cost to our society is substantial and the policyholder, whether small, medium, or large, must accept his share.

Significant adjustments must be made rapidly to allow survival – various governments around the world have already committed themselves in order to keep planes in the air. Meaningful measures will be taken regarding Terrorism coverage. This 2002 renewal might involve fewer, well-capitalized players (and possibly some new ones), as retrocession capacity constricts – meaning a return to sanity, to proper technical rates on normal business.

New loadings will be introduced to cope with terrorism and unforeseeable exposures. New clauses, funds, tools, equalization reserves along with tax advantages are going to florish around the world – hoping that this money put aside will never be needed for another terrorist attack, or cyber risk catastrophe.

In a nutshell, double digit rate increases were needed before September 11th. Now, preservation of market will demand much greater adjustments.

Henry Kleecan Jr., president of Scor Canada

Retrenching, contraction, realigning, re-engineering, refocusing – do these buzz words sound familiar? I’m afraid that they are becoming part of our normal lexicon as 2002 approaches and many reinsurers are taking stock of their position and financial situation for the upcoming renewal season.

Unfortunately, 2001 is only one of a number of consecutive bad years for the insurance/reinsurance industry, a convergence of past years’ underwriting transgressions occurred in 2001, a year where there were very few natural catastrophes in Canada that had a material negative affect on already deteriorating technical results.

The industry’s technical results for underwriting year 2000 was no cause for celebration, quarter-one of 2001 started poorly and we have had little to cheer about since then. Unlike 2000, investment income in 2001 has not come to the rescue, therefore eliminating the financial lifeline that so many have become accustomed to exploit. ROE is at its lowest point in over ten years further exacerbating the frustration of even the most tolerant shareholders.

Over the course of the last few weeks there has not been a day gone by where I do not hear of a reinsurance market either ceasing to write business or decreasing its available capacity. The 2002 renewal market will be a difficult one, but the core of the problems existed prior to September 11. The events of September 11 simply accentuated a pre-existing, albeit fragile condition. There will be many issues, in fact too many to list, for reinsurance underwriters to overcome – some very obvious, others more subtle. Each reinsurer will take a different approach to resolve them, irregardless of the routes that may be taken, I strongly recommend and urge those individuals responsible for overseeing cedants’ reinsurance programs to identify (with the assistance of reinsurance underwriters if necessary) the nature of the information required that will allow the latter to measure their exposures and allocate their maximum available capacity. Quality underwriting information will be critical, and the flight to quality reinsurance is inevitable. We are in the business of reinsurance and intend to practice our profession to its fullest and assist our clients in finding solutions. It is our intent to maintain current capacity levels (and hopefully increase them). But we must satisfy shareholders’ investment expectations and continue to build on our financial strength in order to continue earning your (intermediaries a nd cedants alike) support and confidence as the flight to quality reinsurance accelerates.

Brian Gray, president of Swiss Reinsurance Co. Canada

The Canadian reinsurance market is well into a significant readjustment process being driven both by clients and reinsurers. From the client side, we have noted a much greater interest in reinsurers’ solvency and claims paying ability. It appears that clients are increasingly looking at the total cost of reinsurance: the premium cost plus the cost of uncollectable reinsurance. We anticipate that the demand for AAA security will continue to grow.

From the reinsurers’ side, we anticipate considerable tightening on several fronts. As in all hard markets, we expect reinsurers to reduce capacity – particularly proportional capacity – with clients who have been unable to generate acceptable loss ratios. We expect a continued push to quantify catastrophe exposures in proportional covers accurately, and to adjust occurrence limits accordingly. We foresee strong attempts to refocus treaties on the homogeneous portfolios for which they were created, and to redirect exceptions to the facultative market. We therefore expect a tightening of treaty terms for significant non-Canadian exposures, for very large risks, and for some higher hazard exposures.

Price will undoubtedly be a major target this year. Well before September 11, it was abundantly clear that a significant correction was required. The Canadian reinsurance industry under-performed the primary market in 2000, despite the fact that it was a non-catastrophe year. For capital and capacity to continue to be attracted to Canada, a larger return is needed. We expect increases to be substantial, but at the time of writing it is impossible to predict the magnitude. We anticipate that these higher rates will cause some low-level covers, currently placed below cost, to disappear entirely.

At Swiss Re the increases we quote will not be applied on a broad, across-the-board basis, but will continue to be based on each client’s own exposure and experience. We believe strongly in making the underwriting distinction between programs that need a larger increase, and those that need less. This not only serves Swiss Re well, but we believe it also helps create a more efficient, stable market for the industry, and is part of the role a leading reinsurer should play.

With the corrections taking place we anticipate a very challenging renewal. We foresee the need to work even more closely with our brokers and clients, to keep adjusting programs until a workable solution is created. This year, more than ever, the value of a good client/reinsurer partnership should become evident.

David Wilmot, chief agent for TOA Re

As we ponder reinsurance, it would be a mistake to dwell on catastrophe treaties, even though this class represents Canada’s strongest link to worldwide market trends. Yes, cat rates will increase significantly, and yes, capacity will be available as newly created markets capitalize on those increases. Enough said.

More important is our understanding of why all reinsurance terms will tighten significantly in the coming months. Let us get the simple reasons out of the way. Payback is a concept understood even by the policyholder. Retrocession costs, if in fact, retrocession is available, will skyrocket. Reinsurers, exhausted by one of the most competitive market cycles in memory, were already poised to make price corrections, even before the events of September 11. However, these reasons do not explain the urgency of the increases likely.

One month following the WTC disaster, reinsurers have only begun to calculate their net financial position, to say nothing of gauging their prospects for full retrocession recovery. Analysts suggest that some reinsurers have been mortally wounded. Experience tells us that, at the very least, reinsurance loss estimates must climb, and will continue to escalate for many years to come. Reinsurers must implement significant rate increases, and they must do so in all parts of the world. But, equally important, rates will be driven by lessons arising out of recent events and by a renewed sensitivity to unexpected exposures.

Insurers and reinsurers are now turning their attention to exposure. PML assumptions have collapsed. Capacity layers are now recognized as exposure layers. (The U.S. facultative market has seen a 400% increase, from $500 per million to $2,500, in the price of excess property layers.) Excess treaties will see limited reinstatements. Contingency layer treaties and high layer all-class treaties will be re-examined in the light of unanticipated exposures and will be priced to more realistic return periods. Forgotten exclusions will be reintroduced. Insurers and reinsurers may begin to question the untenable earthquake PMLs being propagated for Quebec and West Coast events. At the very least, we may find that a reinsurance market no longer exists for four-penny rates on Vancouver frame construction. The return to underwriting exposure has been hastened dramatically.Cam Macdonald, regional vice president of Transatlantic Reinsurance Co.The upcoming treaty renewal season will be filled with many challenges for reinsurers and for those companies who purchase reinsurance. Throughout this past year, results for the reinsurance industry continued to deteriorate, and now the WTC catastrophe has magnified the difficulties facing our industry. In order to ensure the long-term survival of the reinsurance terms will berequired beginning with the January 2002 renewal period. It is equally import that primary companies continue to re-underwrite their portfolios and take appropriate measures to improve underwriting results across all lines of business. In the wake of the events of September 11 there is little doubt that rates for catastrophe protections will be dramatically increased, particularly the top layers. Reinsurance companies will also be paying more for their retro protections. The anticipated rate increases on catastrophe and retro covers will not be restricted to the Canadian marketplace as the WTC loss was an international event with far reaching implications for the global reinsurance market. Per risk and proportional treaties will also be affected, and terms will be adjusted to reflect past performance and future expectations. Some companies may be finding it difficult to operate under present market conditions resulting in more merger and acquisition activity, or we may see companies leave the market entirely. Alternative methods of risk transfer may become more attractive if in the mind of the buyer the cost of traditional reinsurance becomes excessive. Going forward, we may see some primary companies increase their retention or change their reinsurance coverage from “pro rata” to an excess-of-loss program in an effort to control reinsurance costs. Discussions relating to coverage issues such as cyber risk and terrorism exclusions will be prominent throughout the renewal season. Facing and solving these and other twenty-first century problems will require the combined efforts of both the primary and reinsurance markets.