Reinsurance Strategies 2003: Keeping the Boat Afloat

While reinsurers will be taking a “tough stance” in the upcoming yearend treaty renewals, company CEOs say they are focusing on developing long-term “partnerships” with primary cedants in a bid to keep the property and casualty insurance boat afloat in a volatile sea of growing losses and new exposures. The market has, however, already claimed several casualties, which just the Canadian environment has seen the demise this year of several primary companies with others ceasing to write new business, while the future of at least one global reinsurer currently hangs in the balance. As a result, the year ahead is likely to be one of “riding the storm out” with potentially higher casualties mounting as the survival list is weeded down to the “meanest and the fittest”.

Estimates by rating agencies, investment houses and inhouse company analysis reports suggests that the capital/surplus within the global reinsurance sector fell by between US$90 billion to US$200 billion following the tragic events of 9/11. The 9/11 terrorist attacks account for about US$40 billion of this amount, with the vast bulk of the difference attributed to vastly reduced value of investment holdings. And, while the past 12 months has seen some new capital enter reinsurance, primarily from the London and Bermuda markets, this inflow has been marginal relative to the overall capital loss. As such, reinsurance pricing will continue in coming years to be driven by reduced capacity and reluctance by companies to accept new risks, the CEOs say.

The loss resulting from 9/11, combined with the volatile financial state of the market induced by plummeting investments, has also heightened attention with regard to the financial security of companies. This will likely see primary business moving toward the fittest players in the upcoming treaty renewals, the CEOs predict. All in all, reinsurers expect that the January 2003 treaty discussions will be comprehensive with a firm view to underwriting profitable business (see below for individual company commentary).

Patrick King, chief agent of ALEA Canada

In my comments for the 2001 renewal season, I referred to the unacceptable reinsurance results in Canada and worldwide during the period of 1998 to 2000. I hoped we would see rate increases in the order of 10%-25% in 2001 on catastrophe and per risk covers. Unfortunately, because of excess market capacity and the industry’s addiction to marketshare, price improvements were frankly, minimal and inadequate. Reinsurers had again deferred their obligation to replenish retained capital and surplus to meet future catastrophe property losses and adverse development on past and future casualty treaties.

Then the worst possible scenario happened with the attack on the World Trade Center (WTC) on September 11, 2001. The WTC loss is now estimated at US$40 billion. The second shoe fell in 2002 with the stock market meltdown, which some observers say has reduced reinsurer’s capital/surplus by another US$160 billion. The combined impact is the removal of US$200 billion of capital/surplus from the market. New investments are around $20 billion, so the net falloff is $180 billion.

Finally, we saw substantial increases on the 2002 reinsurance renewals, particularly for catastrophe business. However, the casualty business, dominated in Canada by automobile liability and accident benefits exposures, is still extremely under priced and needs a reinsurance rate increase of between 40% and 80%. Property per risk covers are still thinly priced as well.

Proportional business continues to create losses to reinsurers. Commissions are unrealistically generous on programs that continue to produce unsatisfactory loss ratios due to long standing inadequacy of underlying primary levels. In addition, occurrence limits are too high. One can only hope reinsurers will address this problem with the 2003 renewals.

Reinsurers will continue to insist on the data exclusion, and the appropriate terrorist exclusion clauses on 2003 treaties. They will be looking to do only one year deals to allow both parties flexibility to meet changing market conditions. Ultimately, companies will look for continued rate improvements to achieve target ROEs and sufficient margins to restore the capital and surplus loss of this and past years.

Catastrophe rates should increase at least 10%-15%. Property and casualty per risk rates need at least 20% and 40%, respectively. That said, there is some light at the end of the tunnel for the first time in six years. The primary market has hardened on most classes in most provinces. Meaningful rate increases are also being obtained on auto and commercial property policies with moderate increases on personal property. This will generate increased revenue which should improve loss ratios on proportional treaties and overall loss ratios in 2003 and 2004. I said it last year and I will say it again, serious reinsurers prefer to provide capacity to those ceding companies interested in a long-term mutual “win-win” relationship.

Andre Fredette, senior vice president of CCR

Looking forward at the upcoming renewal season, there is less panic this year than last year. However, good results continue to elude both insurers and reinsurers. We can see the light at the end of the tunnel, but we are still very much “in the tunnel”.

Pressure from head office as a result of poor first and second quarter results, dropping stock prices, poor returns on investments and deterioration in “old year’s claims” will continue to be exerted on reinsurance underwriters. Briefly, the reinsurance market will probably react to the renewal season in the following manner:

Catastrophe treaty rates will rise by 15%-25%, although there is some new capacity from the London and Bermuda markets which should temper increases;

Property per risk rates will depend on past experience and exposure. Good accounts should renew easily;

Auto excess treaties on low layers (below $3 million retentions) should see significant increases as a result of the dramatic rise in million dollar claims and from the deterioration of past years claims. Increases in the order of 100% for rates will not be surprising;

Property proportional treaty rates have not yet made profits in many cases. As a result, a further round of commission reductions should be expected. Reinsurers will also be calculating the cost of the built in catastrophe protection these covers afford;

Auto proportional treaties will mainly be unplaceable given the current loss ratios especially with Ontario running at 91%. A fix for auto will not happen overnight and may be a couple of years away.

Professional liability in terms of D&O, E&O, surety will all be more expensive to place due to the poor results in the U.S. – and the reduction of U.S. reinsurance capacity.

Overall, there will be a movement by reinsurers to tighter wordings. Expect to see Asbestos and Mold exclusions where applicable. Asbestos is mainly an exposure to Canadian companies which have U.S. locations or who export to the U.S. Mold losses are starting to appear in Canada. Canadian reinsurance exclusions for Mold will follow the IBC wordings where possible.

Reinsurers will be asking for the revised Reinsurance Research Council’s (RRC) “Nuclear exclusion”. This wording has been simplified from the former wording. It will exclude the “fire following” a nuclear incident. In a world where nuclear terrorism has become a possible threat, it was felt that this exposure was not one that could be underwritten. It is also felt that insurance companies should make strong representation to the government to have the Insurance Act modified in order to remove this requirement from primary companies. At CCR, our only mandate is to write profitable business. To this end, pricing adequacy and transparency of underwriting information will be our guiding light. Hopefully by next year we will see the industry returning a profit for insurers, reinsurers and their shareholders.

Matt Spensieri, vice president at GeneralCologne Re

Then one looks back at previous issues of Canadi an Underwriter for “renewal predictions” you note that some have become reality and most only partly so. However, the fact that our industry continues to be plagued by “rationalization” and new challenges is indeed a “reality”.

Some insurers and brokers have historically been concerned with giving too large a share of a reinsurance program to any one reinsurer. This may have been done more out of fear that terms may get too punitive if a particular market were to control the placement, as opposed to smaller shares which could readily be replaced. What is becoming more and more apparent is the need for proper security of the reinsurer, regardless of the size of the participation.

Historical perspectives have been that if a reinsurer was licensed in Canada, that it was adequate security. What we have seen evolve over the last decade is an increasing scrutiny of both the reinsurer and the insurer. There is an ever increasing need for each to maintain appropriate and unequivocal evaluations from the various rating agencies to satisfy the requirements of insureds, investors and regulators, should they wish to keep and expand their portfolios.

I believe the single biggest challenge for the renewal season will be the ability of insurers to partner with a reinsurer that will not only provide some longevity on a program, but also have the financial security and resources to fulfill their obligations, likely many years after this renewal season. As for predicting the 2003 renewals, I will include some observations and preferences that we have at GeneralCologne Re. We will continue to be diligent with respect to obtaining complete data in order to provide terms, pricing and available capacity. Dealing with the potential exposure to terrorism should and will be a concern. Proportional business will likely not disappear to be replaced by excess of loss, but rather will require reinsurers to achieve an adequate margin in order to participate.

Results for Ontario auto continue to challenge our industry. Although legislative changes have currently been tabled the appetite for this line will be limited, especially on a proportional basis, given the inadequate pricing which currently exists. Available capacity for excess of loss will likely not see any significant change, other than on some specialty professional lines such as D&O and A&E. Other lines such as trucking and umbrella business will also see a reduction of capacity. Catastrophe capacity, specifically for Canada will likely not see significant change, even with the “new” capacity available in Bermuda.

Our desire at GeneralCologne Re is to provide capacity, on a direct basis, to those clients who value our unparalleled security, underwriting expertise and resources to foresee emerging issues, allowing both to achieve positive results through disciplined underwriting. Achieving marketshare is not part of this strategy.

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

The good news leading into this year’s January treaty renewal season is that much of the heavy lifting has already begun in earnest. The primary insurers as well as the reinsurers have started to address the pricing, terms and underwriting issues that have led to the unacceptable results of the past few years. By all accounts, there is a resolve to continue with the work already started.

The message about the need for proper underwriting and pricing of our product has hit home. Not only can we look back at the 2001 annual industry results (industry 2001 combined ratio of 110%, an ROE of 3%, with reinsurers’ combined ratio of 119%), but the fallout has started to take place.

The investment community and the ratings agencies are taking action, and so are companies who can no longer wait for the turnaround. We have already seen some reinsurance markets withdraw – some consciously, some through no choice of their own. New capital has entered the market, though not enough to make up for the capital lost by existing players these past few years. We expect certain reinsurers will withdraw capacity, restrict it for certain lines of business or reserve their capacity for a select group of preferred cedants. Reinsurance capacity will continue to be available – but at the right terms.

We anticipate our industry’s position in the current market cycle will translate to another hard market for the coming reinsurance renewal. There will be some additional price increases as well as continued adjustment of treaty terms to address the potential volatility in certain programs that really have not been priced. But, hopefully this will not feel as severe as it may have to some buyers last year. For GE ERC, we feel we recognized the need for correction early. On certain programs adjustments may still be required and many programs still need some additional premium to compensate for the volatility reinsurers assume. We are ready to provide our security for the select group of ceding companies we feel we can develop a strong and deep business relationship with. Those we can focus our resources on. We are looking forward to a treaty renewal that will work for all of us: cedants, brokers and reinsurers.

Patrick Lacourte, chief agent for PartnerRe

Results have been unsatisfactory for the last five years, except in Quebec, where major adjustments were implemented following the 1998 ice storm to restore profitability. But, a single province cannot be expected to offset negative returns in the rest of the country.

In spite of double digit rate increases, Automobile results in most other provinces remain unacceptable. Efforts to control healthcare costs have had little impact. Now, there are new risk exposures threatening our borders, already in evidence in the U.S. Even Europe, which was largely immune to such losses from asbestos, environmental and mold exposures in the past, is struggling with U.S.-style claims. Terrorism also ignores borders, and a number of governments (including Canada) have procrastinated in addressing the issue with positive action.

On a more positive note, some volatile international lines of business such as “energy”, “aviation”, “marine” and large property risks are back to profit in 2002 due to extremely strong actions taken a year ago after 9/11. Canada, however, continues to struggle. With respect to reinsurance, weaker operations will continue to disappear in the months to come due to legacy of inadequate reserves, depressed equity markets, low investment income and unsatisfactory results on in-force portfolios. The key to future profits in this sector is active capital management, proper terms and conditions, right price for the risk transfer, and extensive underwriting and actuarial skills.

Even the financially strong “survivors” have a limited capital base. In order to deliver the stability so much needed by the insurers, there will be no choice but to impose further loadings and exclusions to cope with new exposures. Significant adjustments will be made at next renewal on a global basis on the still unprofitable lines of business. For Canada, emphasis will be put on motor and liability business, agriculture lines and on some areas of property.

This is the price we have to pay in restoring profitability and to ensure that reinsurers can meet their obligations in the years to come with regard to their various stakeholders: clients, shareholders and the public. As Organization of Economic Cooperation and Development (OECD) members recently noted, “reinsurers are effectively the insurers of last resort and as such, are crucial to the smooth operation of the world’s insurance market. A collapse of any large reinsurer would have an important knock on effect.” The politicians should take notice.

Henry Klecan Jr., president of SCOR Canada Reinsurance Co.

Immediate expectations are not great given the context in which the reinsurance market currently finds itself. Reinsurer’s results have been steadily deteriorating over the course of the last few years with combined ratios of 112.9% and 119% for years 2000 and 2001 respectively. Combined ratios in 2001 for the top 10 reinsurers (b y market size) operating in Canada, representing approximately 80% of the Canadian reinsurance market, were in excess of 122%. Results for 2002 are not expected to improve with the cost of historical losses (1999, 2000 & 2001) outpacing rate adjustments.

There is an irony to these poor results: there has not been a sizeable catastrophe loss since the ice storm that affected southwestern Quebec and eastern Ontario in 1998. So, what has caused this weak financial performance? The causes should not be surprising to the reader – very poor auto results in Ontario, Alberta and Atlantic Canada along with increased loss activity and severity in the mid-market property commercial portfolio. In addition, both large industrial risks and liability related losses have also shown increased claim activity.

There has been a lack of underwriting discipline producing very poor technical results that neither the insurance or reinsurance industry can afford to maintain. Underwriters should not be focusing their attention on marketshare or the so-called “prestige account” to justify the wrong course of action to adopt. As predicted in 2000, shareholders have reacted. Some reinsurers have decided to close their Canadian operations in 2002, others will be willingly reducing their underwriting capacity or culling their portfolios in order to rebuild their operating platforms so as to regain the confidence of shareholders and rating agencies. Increased capital allocation will only be provided to those entities that can demonstrate the best ROE.

Prediction for the 2003 renewal season: terms and conditions will determine the level of capacity provided to insurer clients, while detailed underwriting will be the rule rather than the exception. As such, I urge and encourage that renewal underwriting submissions be thorough and precise as historical track records will be scrutinized and last but not the least important, rate increases will be the “de rigueur”.

Brian Gray, president of Swiss Reinsurance Co. Canada

More and more it seems, reinsurance is not for the “weak of heart”, or the weak of balance-sheet. Just as the industry was clawing its way out of one of the most extended soft markets in history, a number of capital depletion events conspired to test markets worldwide.

In 1999, while Canadian players were recuperating from the 1998 ice storm, reinsurers were rocked by the second-worst year ever for global natural catastrophe losses. 2000 was more benign for catastrophes, but mid-year marked the start of the bear market in equities that – to various degrees for different companies – has continued to erode capital until the present. The hits intensified in 2001, with the combination of 9/11, bond defaults, and the ongoing equity erosion. In Canada, Ontario auto results were the exclamation point to a dismal underwriting and investment year.

In all, Swiss Re “Economic Research” estimates that about US$90 billion exited the global industry in 2001. Despite inflows of US$30 billion, the cumulative decline since the peak in 2000 has been approximately US$180 billion, or 25%, of global non-life capital funds. With capital now less plentiful, and with reduced interest income and sharply lower capital gains, the industry has no choice but to return to fundamentals and seek increased earnings from the underwriting side.

If reinsurers are to continue to attract capital to our business to absorb volatility, rates must go up further. We anticipate that reinsurance increases will be milder this year than last, but that the market will still settle with double-digit increases as the norm. As always, Swiss Re will underwrite and price on a case-by-case, account-by-account basis.

On coverage issues, there is now strong primary market momentum to exclude mold exposures, and we anticipate that this will be mirrored in reinsurance contracts. Also, reinsurers will likely move to exclude asbestos, particularly for U.S. exposures, given the resurgence of new claims activity south of the border. Reinsurers will likely begin the job of introducing exclusions for fire following a nuclear event – a process that will require concerted industry action at all levels.

We believe that several reinsurers have had their local underwriting authority restricted, and that the range of true quoting markets will be narrower than in recent years. We expect that the security of all reinsurers will continue to be an issue for most buyers, as they continue to consider the potential cost of uncollectable reinsurance.

David Wilmot, chief agent for The Toa Reinsurance Co.

of America

Despite predictions of continued market hardening, a number of Canadian reinsurers may still fail to “get it right” this renewal season. The world’s major reinsurers (the parents of most Canadian reinsurance branches and subsidiaries) are only now gauging the full extent of the damage inflicted upon them – and self-inflicted – over the past half decade. Many have been downgraded. Several are now unsellable.

Remarkably, the performance of these reinsurers has prompted the world’s Organization of Economic Cooperation and Development (OECD) to place the entire industry under close scrutiny. But, even as these reinsurers have used the past 18 months or so to reinvent pricing and underwriting discipline, their Canadian offspring seem to have adopted a far less urgent approach. Arguably, much of Canada’s in-force reinsurance is still priced below cost, allowing nothing for a margin for return on equity, growth, or funding of future loss severity.

Current quota share treaties continue to lend capital at terms no bank could stomach, and yet these “financial” contracts add performance losses, free shock and catastrophe protection, and seek no commitment for eventual recovery. Capacity excess treaties undercharge as though there have been no recent losses, yet discount if there has been a shock loss (presumably on the premise such losses were, well, exceptional). Reinsurers sell “unindexed” excess of loss protection for an indexed automobile product, and do not imagine that reported large losses will ever develop, despite clear evidence that almost all past losses, including no fault losses, have developed with stunning predictability (or, if you will, a “predictability” that nevertheless seems to stun some underwriters).

Canadian reinsurers must first grasp the true cost and value of their products if they are to communicate that value to insurers. Is there anything sorrier than a reinsurer seeking inadequate rate increases from nevertheless incredulous and irate buyers? Ineffectual underwriting does not help the reinsurance buyer. Rather, it supports weak and reckless markets, removes needed premiums from every level of the property and casualty insurance industry, exacerbates the dramatic swings in market cycle, and debases the constructive advice and guidance that a strong reinsurance community could offer. That has proven to be untenable.

Over the short term, a number of domestic reinsurance offices have lost their underwriting pens. Over the long-term (if there is to be one), reinsurance partnerships may again be guided by a business sense that serves reinsurance buyers rather than merely placating them. Perhaps that long-term begins now.

Cam MacDonald, regional vice president of Trans-

atlantic Reinsurance Co.

The upcoming reinsurance renewal season will feature a continued tightening of treaty terms and conditions. Third quarter year-to-date results suggest further adjustments to terms are necessary if reinsurers hope to realize an underwriting profit in 2003.

Many pro rata treaties remain unprofitable, while several large individual property losses have negatively impacted per risk treaties. Ontario automobile continues to delay any improvement on many casualty covers. In order to ensure the long-term survival of the reinsurance market in Canada primary and reinsurance rates must continue their upward climb throughout 2003 and well into 2004.

The cost of retrocession protections for reinsurers continues to rise thereby adding another layer of pressure to reinsurance terms and condi tions. Natural and man-made disasters still plague our industry with little end in sight. Large loss loads that have been absent for many years must be reintroduced to the rate making process in order to help return individual primary and reinsurance contracts to profitable levels.

Catastrophe rates for 2003 are likely to increase 10%-15%, while per risk and casualty covers will experience a similar level of minimum rate increase. Commission terms on pro rata protections will be adjusted to allow a profit margin for reinsurers as many of these treaties have been unprofitable for far too long.

The latest round of mergers and acquisitions (M&As) activity is further evidence that the reinsurance market has lost some of its luster for many potential investors. The flight to quality is now more evident than ever before as continued poor results test the staying power of many organizations. While it is true that some companies may initially benefit from the withdrawal of certain organizations from the Canadian marketplace, the demise of these companies should be at least somewhat disconcerting for the entire industry. As declining investment returns continue to be the norm, it is now evident that most, if not all, underwriters finally realize that any measure of profit for their respective firms must come from underwriting. At long last it appears that some basic underwriting principles and practices have been returned to the marketplace, a change that has been long overdue.

In addition to rate adjustments, coverage issues will be front and center during the renewal season. Exclusions relating to mold, asbestos and nuclear exposures will be explored. To date, reinsurers operating outside Canada have chosen to not undermine local efforts to improve the results of various treaty contacts particularly catastrophe covers. An adherence to underwriting for profit is now an international mantra shared by many of our colleagues around the globe and we salute their underwriting resolve.