Reinsurance Strategies 2005: Stability?

The Canadian property and casualty insurance industry has been spared any major catastrophic losses over the past year – at least relative to the global situation. Primary companies through to reinsurers have reaped the benefits of declining loss ratios and rising profits. So much so, that the insurance industry’s “prosperity” has attracted negative political and media attention, and most recently, intermediary remuneration arrangements have been put to question by the regulators.

Putting aside the negative publicity the insurance industry has been targeted over the past 12 months, the current operating environment appears to favor a period of stability. Barring any unpleasant surprises in the short-term, reinsurance CEOs expect that cover renewals for 2005 will remain largely unchanged in both price and terms. Most importantly, most of the commentators included in this review believe that reinsurance capacity – from both traditional and new players – has reached adequate levels in most lines of business, which should serve to temper rate increases. The coverage issues that will come to the fore in the upcoming treaty renewals will be specific to each treaty and line of business, they say.

However, reinsurers remain concerned over certain areas of the Canadian market, the most obvious being exposure to the volatile auto line. As a result, reinsurers are unlikely to be generous with regard to renewing lower layers of large, auto casualty excess of loss programs. Liability, as a whole, remains under-priced, reinsurers say, and further upward, but moderate price corrections can be expected.

Global natural disaster catastrophes experienced this year – including the four major hurricanes to have struck the U.S. and the Caribbean coupled with the typhoon losses from Japan – will also place a restriction on the available capital and therefore risk appetite of the international reinsurance companies, the CEOs say. And, some of the commentators observe, the relatively “small window” of financial relief that the industry has experienced over the past two years has been insufficient to recharge depleted reserves. The financial rating agencies will therefore maintain close scrutiny of companies in the coming year with a keen eye on “reinsurance recoverables”. All of which point to a period of recovery and moderation – but not abundance.

Andr Fredette, senior vice president of CCR Canada

Every renewal season seems to have its flavor or peculiarities. This season may be characterized by having less compelling issues than in the past. Part of the reason is that last year the results for Canadian domestic reinsurers were generally favorable with a combined ratio of 96%. So far this year in Canada we have been spared from any large catastrophe losses and the rates levels up till recently have been holding. Baring any last minute surprises, most reinsurers should post favorable results for 2004.

The issues will be specific to the treaty and lines of business, most likely based on the following:

Property catastrophe Originally we expected a softening of 10%-15% on rates. However, given the hurricanes in Florida and the Caribbean, along with the cyclones and earthquakes in Japan, this should be revised to a possible “renew as is”. Some Canadian insurance companies feel that losses that occur in other parts of the world should not impact their prices. However, the world property catastrophe market capacity only exists because of the world market volume and Canada on its own would not be able to generate that capacity.

Property pro-rata most treaties did well last year and renewals should go smoothly.

Property excess Terms will be based on specific treaty experience.

Liability Some reinsurers are still suffering from legacy claims that occurred a number of years ago. Therefore this market will continue to be limited to domestic players and terms will be based on treaty results. While rates have gone up significantly in the last few years, it will take some time before they are adequate. Many reinsurers are avoiding directors’ and officers’ (D&O) covers for the large publicly traded companies.

Auto excess Reinsurers’ appetite for this class of business has dropped significantly over the last three years. Results have generally been poor for reinsurance companies, especially those involved with lower layers below $3,000,000. The problem was caused by the slowness in the companies to recognize that a number of their claims were under-reserved and would ultimately penetrate the reinsurers’ excess layers. As a result, the development of the old years experience has been poor. The various reforms in the different provinces have reduced the number of small fender bender and soft tissues injury claims. However, these have done nothing to reduce the serious catastrophic losses where most reinsurers are placed to respond. There should be hard negotiations this year on the price for the various auto excess layers.

Other various miscellaneous classes of business, Surety, Marine and Aviation have done generally well and there should be a normal renewal for these. There is still considerable pressure on local reinsurers to produce good results from head-offices.

Peter Borst, chief agent for Canada at GE Insurance Solutions

By all accounts, our industry has reached the point of profitability. In fact, a number of insurers had an outstanding year due to the price and underwriting discipline they have exercised over the past few years.

It should be pointed out this is somewhat skewed by the reluctance of many insureds to submit small claims that may move them to an unfavorable risk category.

Reinsurers have enjoyed improved experience as well, though not to the same extent as their primary customers. All of this is good news for the marketplace, as well as buyers of protection, who demand long-term financial security. However, now is not the time to become complacent. In 2003, the industry began to show signs of a rebound with an ROE of 11.2% and a combined ratio of 98.7%. This optimism is tempered by the fact that, on average, the financial services sector in Canada generates around 15% ROE.

Ours is a global market and the major catastrophes of 2004, including Caribbean and U.S. hurricanes and Japanese typhoons, will require significant contributions from all markets to spread the losses. For the coming renewal season, I expect the reinsurance market will maintain underwriting discipline as results are currently “acceptable” but not outstanding (particularly considering that reinsurers experience greater volatility in underwriting accounts than insurers). Look no farther than the rating agencies for a barometer of the performance of reinsurers. Ratings agencies will hold the line and be very judicious about issuing upgrades until they see improved performance and restoration of capital.

For the Canadian marketplace, I foresee the following impact on these key lines of business:

Property catastrophe – Global weather activity will impact pricing, where some increases will be taken. Another factor is that insurance values for homeowners business may be understated by 10%-20%.

Property risk – This segment is experiencing greatly improved results and strong primary price. It is worth noting that the introduction of new players mostly focusing on short-tail lines will generate vigorous competition. A number of ceded programs already are adjustable and therefore terms reflect the good results of this past year.

Automobile – Expect tight terms and perhaps additional price increases. This is due to loss development over the past few years as well as uncertainty over the impact of current product(s) changes on excess programs.

Casualty – The market for this line of business should remain firm. Fewer reinsurance markets have the appetite or financial capacity to allocate their capital for casualty lines, which has performed poorly.

At GE Insurance Solutions, we will continue to look for short-tail lines of business to support our mix of longer tail-lines. Our focus will be on middle market bus iness where terms remain more consistent over time. We will maintain our underwriting discipline to help endure market cycles.

Matt Spensieri, vice president of General Reinsurance Corp.

As an industry, but certainly company by company, we are anxiously awaiting yearend, to provide certainty to what appears to have been a very positive underwriting year. Absent any significant natural disasters or other numerous large losses, the Canadian insurance industry may actually produce a combined ratio below 100% for this year. For many of us who work in this industry, it is a target we generally strive to achieve, but not always with success. Profit, although generally accepted as an outcome of a business enterprise, is often seen as a bad thing, and quite often not acceptable for insurers to achieve.

Insurance, which has historically been referred to as a staid or uninteresting industry, has most recently achieved unprecedented exposure and notoriety. Although much of this recent publicity and complicity relates to alleged actions south of the border, the reactions are also being felt here in Canada. Rapid change is not what is normally associated with insurance. However, regulators have already instituted requirements for both brokers and insurers for full disclosure to insureds of remuneration/payments to agents and brokers. Our world has changed, very quickly. For the foreseeable future, we will all be under greater scrutiny, even more than we normally expect.

That said, what can we expect for the upcoming treaty renewal season? Probably, not much change. As is customary, competition will always have an influence in our industry. However, what we are currently experiencing is a move to more centralized decision making. A disciplined and consistent underwriting approach will resist the temptation to arbitrarily or universally reduce premiums without merit, or simply to maintain marketshare. What would have otherwise been viewed as softening reinsurance market in Canada, may resist, as a consequence of the natural disasters in other parts of the world. My prediction is not much change either in pricing or terms and conditions.

Primary rates have already begun a downward spiral, other than in certain specialty areas, in an effort to maintain profitable business. The sensitivity of reduced pricing to the speed at which an underwriting loss will be produced, is not always recognized. The influx of new reinsurers in a slowly shrinking market (latest example being ING buying Allianz Canada) will also likely increase competition. None of us may accurately predict the outcome of the upcoming renewal season. Public and regulatory oversight may cause us to re-examine our decisions, but competition will remain strong. The need to maintain underwriting principle and partner with reinsurers with utmost security and underwriting resources has never been greater.

Nicholas Smith, attorney in fact in Canada for Lloyd’s Underwriters

Lloyd’s underwriters have been playing an increasing role in the Canadian reinsurance market, and are cautiously anticipating a positive renewal. Lloyd’s Canadian reinsurance income has grown steadily from about $100 million in 2000 to $165 million in 2003, a level which it has surpassed in the third quarter of 2004.

Many reinsurers around the world are consistently stressing the need for pricing discipline. Lloyd’s is no exception – on the contrary, it has been one of the most vociferous. The good news for Canada is that since the treaty reinsurance market has mostly been adequately rated in recent years. The main challenge is therefore maintaining that level of risk-adequate pricing. Treaty leaders I have spoken to do not expect major changes to treaty ratings in Canada, especially after the international catastrophe losses in the third quarter.

“The impact on the global reinsurance market of the four Atlantic storms and the major typhoon in Japan is such that discipline will almost certainly be maintained in the Canadian renewals,” says Andrew Carrier, active underwriter of Kiln Catastrophe Syndicate 557. “Supporting that, models are getting ever-more sophisticated at assessing the peak exposures in the Fraser River delta area,” he notes. Chris Sharpe, treaty reinsurance underwriter at Hiscox Syndicate 33, agrees that it should be a smooth renewal. “Canadian insurers with programs led in the Lloyd’s market can expect an “as before” renewal, provided exposures or business plans have not changed materially,” he says.

On technical issues, Lloyd’s has responded to concerns over event definitions for brushfire, either by providing reinstatements within an event, or adjusting the event definition to ensure seamless coverage of future similar fires. On fire-following terrorist losses, Lloyd’s underwriters remain optimistic that Canadian cedants are making progress on the issue of exclusions, and hope to see resolution over the next 12 months. In the meantime, they say they remain willing to provide a backstop for this risk. In Canada and throughout the world, Lloyd’s will remain steadfastly disciplined in its underwriting approach. Adequately priced treaties will continue to find supportive Lloyd’s underwriters, both under existing relationships and through new ones.

If market rates drop to levels which fall below Lloyd’s underwriters’ strict pricing thresholds, Lloyd’s underwriters warn that they will not be willing to give too much away. However, in the current global climate no such changes are anticipated.

Ken Irvin, president of Munich Reinsurance Co. of Canada

We are optimistic about the upcoming treaty renewal season. Financial stability has returned to our industry, and although it may be premature to call it a trend, we are encouraged. We believe the lessons learned in the last soft market are etched in the minds of today’s underwriters and management – they certainly are in ours.

The issue of declining rates in the marketplace is specific and narrowly applies to certain classes of risks that experienced massive rate increases over the past two years due to capacity shortages. Capacity is no longer an issue for these classes. We find the vast majority of companies are holding prices at technical levels, and are not seeking marketshare at the expense of bottom-line volatility. Retentions have increased at the primary level, reflecting an increased equity base resulting from higher earnings and/or a belief that prices are adequate enough to retain more risk.

Risk management, consolidation and transparency, which are amongst today’s current business issues, together with adequate pricing, are all signs of a healthy marketplace. In light of the encouraging trends above, the industry is primarily concerned with stability for this treaty renewal season – price, capacity, knowledge and credit worthiness are the interdependent qualities of reinsurers sought by prudent buyers. Thus, in this positive environment, we are confident in our ability to continue to pursue a common-sense approach to risk-adequate pricing in our portfolio. This practice not only supports our client base but will also establish a sustainable earnings stream over time acceptable to investors and other stakeholders.

Pierre Michel, chief agent for Canada at PartnerRe SA

Two items are unique to the Canadian insurance marketplace and will contribute to its profitability or lack thereof in the short and medium term, depending on how they are resolved.

Firstly, a vast majority of insurance companies have not yet excluded all consequences of terrorism. Most policies do not exclude fire losses following a terrorist attack. This exposes insurers, even more so than it does reinsurers who have imposed event caps with the obligation to make good on astronomical amounts of compensation in scenarios that, granted, may seem far-fetched, but are not altogether unconceivable.

Secondly, a conundrum is posed by the surprisingly low frequency of insured claims in 2004 for some lines of business in some provinces. Opinions on whether or not such a trend is sustainable diverge. In case it turns out to be only tempora ry, insurers that have confidently planned on a recovered profitability level based on that factor may well enter into a vicious circle of structurally inadequate pricing when, for heterogeneous reasons, it reverses itself.

Turning to worldwide developments that may have repercussions on reinsurance in Canada, let us look at the infamous “industry price cycle”. I will list my conclusions first:

Reinsurance cycles will continue to exist;

Cycles are bad, or, to phrase it less childishly, they lower the efficiency of the market;

The amplitude and duration of cycles can be mitigated through behavioral changes, thereby creating a paradigm shift; and

That this “paradigm shift” might very well be taking place right now.

A number of observations support those assertions, as we are seeing an extremely powerful and interesting combination of changes in the paradigm governing reinsurance business:

An ever-strengthening analytical approach to pricing and underwriting;

The focus of company boards and senior executives remains on sustained profitability;

Better awareness by shareholders themselves of the returns they are gaining;

Enhanced scrutiny by analysts and rating agencies;

The regulating agencies’ ever more demanding approach to surplus ratios, and perhaps more importantly, internal controls, and risk identification and mitigation mechanisms;

The growing consciousness that terrorism, climatic changes, judicial inflation and concentration of wealth in modern societies pose serious challenges and require unabated pricing and underwriting discipline;

An increasingly risk-averse attitude from the majority of insurance companies;

Insurers’ and brokers’ clearer realization that reinsurance cycles accentuate volatility – which is a paradox, as reinsurance is supposed to do exactly the opposite, namely absorb volatility; and

Ceding companies and brokers increasing focus on assessing their reinsurers’ capacity to overcome what we at PartnerRe call “shock losses”.

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

The 2005 renewal season is virtually upon us. Numerous preliminary meetings with cedants, and reinsurance brokers have been taking place since early September in order to obtain a better read of the market for the upcoming renewal season.

Canada has been spared catastrophic events this year (although the year has not ended). But, weather related losses in the U.S. and Japan have some members of the global reinsurance community reviewing their catastrophe risk models, which may need updating. The federal regulator is also maintaining its vigilance with the introduction of a quarterly reporting requirement for the reinsurance industry. And, shareholders’ anxiety levels have not as yet diminished with the industry as a whole continuing to be scrutinized by global rating agencies.

With this backdrop, what is expected from reinsurers? There should be no surprises. SCOR will continue to practice its profession in a responsible and realistic fashion that has earned the respect of cedants and brokers alike. There is abundant capacity, but only at the right price. The theme to date, at most meetings within our industry, has been price integrity and underwriting discipline. I concur with this assessment and it is hard to imagine a return to the soft market conditions of the late 1990s which has been exceptionally brutal – companies are still recovering from it.

The Canadian reinsurance industry is in a recovery period but it is not consistent across all business lines and the recovery period itself has not been long enough. The majority of the reinsurance industry is part of a global market place with financial expectations. Some anomalies may occur, but in general we should expect very few surprises with no company wanting to be outside of the financial framework to which we must adhere.

Brian Gray, president of Swiss Reinsurance Co. Canada

In 2004 the Canadian reinsurance industry, like its primary market cousin, should produce a reasonable return. Reinsurers’ current challenge – as perhaps it is for primary commercial lines writers – is to provide greater reliability in product costing, for the benefit of all stakeholders.

From the consumer’s point of view, credibility is lost every time the industry over-corrects. Adjusting price levels to last year’s GAAP earnings, or to abnormally good or bad investment returns, instead of to the underlying cost of producing the next year’s reinsurance contract, creates pricing volatility that our clients cannot understand. Reinsurers must carry their share of the burden in understanding their exposures and pricing them accurately in advance, rather than continuously ‘catching up’ afterwards. This is not an easy task in an environment where exposures continue to change and can take years to emerge as claims. Yet it is an area in which reinsurers need to continue to invest in 2005, in order to provide good costing for clients.

From the investor’s point of view, our profession’s notorious inability to cost our products consistently and well leads to scepticism about the attractiveness of the industry. The good news continues to be that those who do succeed in evaluating their exposures well and pricing accurately, will outperform: first, by providing a more reliable product to clients when they need it, and secondly by taking advantage of the cyclical inefficiencies in the market, to generate superior returns to investors.

On a line-of-business basis, we anticipate that exposures to catastrophe perils will remain largely unchanged from 2004, and that this market will be stable. The environment for excess automobile coverage continues to be harsh, as government-mandated rollbacks in primary auto rates combine with growing claims costs for catastrophic auto injuries. Liability exposures are complex, and vary considerably from program to program. Adjustments in this line are likely to be made on a case-by-case basis.

The security of reinsurers has been a concern for buyers over the last two years, and we anticipate this will continue. Increasingly we expect companies to interpret the cost of their cover as the sum of the premium paid to reinsurers plus the value of claims that cannot be recovered from them.

The open market mechanism is harsh yet efficient. Reinsurers who invest in understanding their clients’ portfolios, in providing quality capacity and solutions, in delivering reliable pricing based on underlying costs, and in providing attentive claims paying services will continue to add value to the industry. They will earn a responsible return, will continue to attract capital to the market, and will earn the right to keep servicing clients. And as in any market, those who are less successful in delivering value, will not.

David Wilmot Sr., senior vice president for Canada at Toa Reinsurance Co. of America

Try this on your portfolio! Even in a quiet market, standing still means falling behind. The current treaty renewal season is being characterized as peaceful – without major or contentious issues. However, forces that threaten the future of insurer/reinsurer relationships will not be exorcized by a single year of improved results.

Past losses have not been “re-capitalized”, and multibillion-dollar deficiencies in reinsurance recoverables continue to worry the rating agencies who oversee insurers and reinsurers alike. Legacy reinsurers (the ones who carried the market through the past seven years or so) are ill equipped to enter a new round of competition. True, those upstart short-tail markets that entered with “exit in mind” will compete. But, it is worrisome to watch them now try their hand at the long-tail business they eschewed only a season ago.

I am disheartened by buyers, brokers and, yes, even reinsurers who look at reported excess auto and casualty losses and draw conclusions about their relative profitability. It is extremely difficult to get those classes right. In fact, reinsurers have rarely ever gotten them right. The tail on such business continues to grow due to the “Americanization” of our c ourts and to the increasing availability and use of escalating medical services. This renewal, casualty reinsurers will attempt to price 2005 losses that will be resolved 10 years from now by juries and medical professionals who, in turn, will try to estimate the future cost of care, treatments and lost wages another 10 years further into the future.

Consider just one pricing factor: Inflation does not fall equally on insurer and reinsurer alike. Using a very conservative 6.5% for medical inflation, the effect on an excess treaty becomes, well – instructional. If losses above a retention of $2,000,000 average three per year worth $2,450,000 from ground up, then 6.5% inflation will turn their average into $2,609,250 – a 35% increase to the excess reinsurer! This seems like a lot, but the 35% figure is still not correct. There is also a very real possibility of losses below the $2,000,000 retention now inflating into the layer. Thus we may have a fourth loss – perhaps $2,100,000 – and a revised excess inflation rate of 43%. Ignoring myriad other considerations, this increase will merely allow the reinsurer to stay in place – try this on your portfolio!

Those reinsurers who get factors like this terribly wrong will become the “recoverables problem” of the next decade. This year, I expect reinsurers to “stay in place”. I believe that neither they, nor their customers, wish to sabotage one another’s balance-sheets seven years hence.

Cam MacDonald, regional vice president for Transatlantic Reinsurance Co.

Industry consolidation is now a common occurrence in our marketplace. With each passing year we witness another round of merger and acquisition (M&A) activity, and 2004 was no exception. The flight to quality (“A” rated) capacity is very evident particularly with regard to long-tail casualty lines. This trend is likely to continue for the foreseeable future.

Throughout the upcoming treaty renewal season many accounts will be renewed at or near expiring terms. The cumulative effect of year over year rate increases has improved the loss position of many accounts that until recently were unprofitable.

Although industry results appear to be improving several daunting issues remain. Ontario automobile remains an enigma. Some companies report an improvement in their automobile line of business while others have experienced little change. Of particular concern to reinsurers is the rising trend in the number of large auto losses affecting several layers of casualty excess of loss reinsurance programs. This rise in frequency will likely temper any downward rate pressure on excess of loss treaties.On the property front the rise in number of natural catastrophes throughout the world remains a concern. The recently concluded severe hurricane season affecting the Caribbean and south east U.S., along with “local” events in Edmonton and Peterborough, should have a stabilizing effect on Canadian catastrophe rates and international retrocession costs. Catastrophe models will likely be adjusted to more accurately reflect the frequency of large losses experienced during the 2004 storm season.

Catastrophe retention levels will be revisited and there may be renewed interest in aggregate covers. Recent improvement on pro-rata treaties, although welcome, should not be over emphasized. It was only a short time ago that many of these contracts were in a deficit position. Terms on pro-rata treaties should remain more or less “as is” given their long term historical results.

If you do not lean from history you are doomed to repeat it. Throughout the past year there has been considerable discussion about a looming soft market in Canada. It seems unconscionable that underwriters would throw away all that they have worked so hard to achieve. Now is the time to maintain underwriting integrity and price stability to avoid lapsing back to a time that created so many problems for our industry. In a historical sense it was only a short while ago that combined ratios far exceeded 100% and many companies found themselves in great difficulty because of their indifference toward maintaining sound underwriting principles and practices. 2005 will test the resolve of our underwriting community and let us hope the sins of the past are not repeated.