Suspended Animation

Canadian Underwriter asked several reinsurance chief agents and CEOs to discuss what they believe to be the single most important issue facing the Canadian reinsurance industry going forward into 2010. The answers presented below (in alphabetical order) vary considerably, but at least one common denominator underlies several of the financial concerns. One theme is characterized here by a state of suspended animation commonly portrayed in the world of cartoons.

One popular cartoon has a coyote chasing a roadrunner off the edge of a cliff. Several seconds after he runs over the cliff edge, the coyote continues to travel in a straight path, the roadrunner having disappeared from view. Then the coyote stops in mid-air and floats motionless for a few seconds, pondering his predicament. At last, the coyote plummets to the earth like a stone, often making some kind of futile gesture to protect itself from the fall.

The coyote’s state of suspended animation — i.e. hovering between the safety of business-as-usual (chasing the roadrunner) and a state of extreme danger — may well characterize some of the reinsurers’ concerns about the overall state of the insurance industry headed into 2010.

On the one hand, reinsurers see primary insurers continuing to chase market share through reduced premium pricing. On the other hand, reinsurers see the proverbial cliff ahead, representing the danger of escalating claims costs.

Reinsurers are now wondering whether the insurance industry as a whole can stop itself from chasing business over a cliff. And if, as some might argue, the industry has already launched itself over the precipice of safety, how long will the industry be able to hover safely, in a state of suspended animation, before dropping like a stone into the danger zone of high claims costs and runaway inflation?

1 Francis Blumberg, Chief Agent, PartnerRe

The re/insurance industry offers products and services that help others manage their risks. The past 18 months have demonstrated that no matter how well we try to understand the risks, there will always be some risks or a correlation of risks we do not anticipate or get quite right. Re/insurers can hold additional amounts of capital or include additional margins within their pricing, but a potentially discomforting level of uncertainty will always remain.

As we approach the end of 2009, investment results are improving, but claims are still increasing. It’s important to have a long-term view of risk.

Under-pricing risk is not sustainable and ultimately does not benefit either reinsurer or insurer. Therefore, as rates continue to soften below technical price, we need to look at the risk factors that we do understand, such as the risk-free rate and loss trends.

Risk-free rate is an important pricing measure. It is essentially the yield that we will earn on the premium that we receive before we pay out claims. The higher the yield (and the longer the duration), the lower the required premium and vice versa. The return on risk-free investments has decreased dramatically over the last 12 months and will remain this way for the foreseeable future. Equally, increased loss trends are emerging in many lines of business; with every passing year, we have better data and additional knowledge about the expected claims costs.

If we ignore the tangible facts that we do know, such as interest rates and loss trends, we might end up in another costly exercise. This would be a pity given the Canadian re/insurance industry has fared better than others in the most recent crisis.

2 Christophe Colle, Branch Director, Chief Agent, XL, Reinsurance America Inc. (Canadian Branch)

Large losses this year have affected property reinsurance treaties, both per risk and per event (catastrophe) treaties.

We have noted an increased frequency of large risk losses in the Canadian market over the past two years. This is not unusual in a long economic downturn. As a result, some insureds have cut back on their maintenance budget. Larger risks are often subscribed, meaning several risk programs can be hit by one loss resulting in an accumulation loss for reinsurers.

Several small, weather-related events have occurred across the country this summer, leading to sizeable insured losses. Damages related to non-modelled perils like sewage backup in particular, and water-related losses in general, are increasing every year. This reflects the high concentration of sums insured, combined with sewage network issues in several cities. Also, an updated RMS earthquake model will increase PMLs significantly across the return periods, affecting its output for pure premium and standard deviation.

In casualty, inflation is usually more noticeable in the reinsurance market, since the reinsurance market operates on an excess of loss basis in Canada. With this in mind, we are closely monitoring two types of inflation.

In the foreseeable future, economic inflation is expected as a result of government deficit spending and could increase the magnitude of casualty losses. Social inflation continues to rise in settlements — mainly for long-term, future care costs — and is escalating to record levels.

3 Carol Desbiens, Chief Agent for Canada, Paris Re

The Canadian (re)insurance industry is currently facing significant issues regarding its profitability. Last year, the return on equity (ROE) for the industry dropped to a disappointing 7.5%, the lowest level since 2002. Although the industry is well capitalized, we have seen a decline of 3.8% of its capital base resulting from underwriting losses and investment write-downs. The current trend is not encouraging and the ROE will continue to decline in the near future.

Several factors contribute to this situation:

• Rate inadequacy prevailing for the majority of the market (specifically for personal lines), due to the unsustainable auto insurance regime in Ontario that is desperately waiting for an in-depth reform, as well as to intense competition and over-capacity;

• Extreme weather causing more frequent and widespread damage across the country;

• The recent financial and economic conditions, which have limited the capacity of the insurance industry to increase its income as a result of historical low returns on invested assets and the slowdown in policyholder spending on insurance products. Reinsurers have not been immunized

against these difficult conditions. In addition, premiums assumed by licensed reinsurers in Canada represented in 2008 only 4.6% of direct written premiums by primary companies. This is less than half of the same ratio observed in 2002. This steady decline has been caused by the strong performance of primary insurers over the recent recovery period. It is also a product of the consolidation of the market, which caused insurers to convert proportional treaties into excess of loss treaties and retain more risks by increasing their retentions. Consequently, reinsurers are now assuming more risks because their portfolio is subject to more extreme and volatile exposures.

The reinsurance industry should now, more than ever, focus on disciplined underwriting and deploy its capital only where reasonable expected returns are commensurate with risks. In the long term, this is the only way to protect policyholders, shareholders and employees.

4 Andr Fredette, Vice President, General Manager, Caisse Centrale de Reassurance (CCR)

When asked to name the most important issue facing the Canadian reinsurance market in 2010, the thought of Sisyphus came to mind. Sisyphus was a Greek king cursed to roll a huge boulder up a hill, only to watch it roll down again, condemned by the Gods to repeat this action eternally. The issues facing the reinsurance market are a variation of those we have faced in the past:

• Volume: You may have noted that Canadian reinsurers’ volume over the last five years has declined due to abundant capitaliz ation of primary companies. In 2009, with the financial crisis in full bloom, most insurance companies decided to continue to use reinsurance capital and most proportional treaties were renewed. Now that things have improved somewhat, it is expected that some companies may reduce or withdraw their proportional treaties and book the premium net for themselves.

• Rates: Primary rates have been stalled in spite of more frequent windstorms, water damage claims and large fires. If primary rates do not go up, this puts more pressure on reinsurers to raise their own rates.

• Investments: We are seeing historically low interest rates on insurers’ and reinsurers’ portfolios. If investment income is down, then the difference has to be made up from underwriting income.

• Insurance claims: We have seen a frequency of small to medium cat losses this summer. Most notably, the Alberta storms in the beginning of August will cost the insurance industry an estimated Cdn$400 million. Large fire losses seem to have increased in the last year; whether this is due to cutbacks in maintenance or arson is hard to say. Lastly auto accident benefit claims continued to be a problem for the industry.

To sum up, all of the above issues will challenge reinsurers in maintaining profitable results during what we hope is the near end of the soft cycle.

5 Jean-Jacques Henchoz, President and CEO, Swiss Reinsurance Company Canada

Most leading reinsurers have seen capital losses start to bounce back, and the global imbalance of supply and demand has eased to some extent. For 2009, the property and casualty reinsurance industry is heading for a 10% ROE, provided there are no further major loss events. The combined ratio is expected to be in the mid nineties, broadly in line with 2008 results.

In Canada, reinsurers remain concerned about continued downward primary rate pressures, causing further erosion of margins and declining ROEs. They will also further direct their attention to any broadening of underlying terms and conditions. Recent weather events in British Columbia, Alberta and Ontario have contributed to deteriorating profitability, reminding us about the increasing frequency and severity of weather patterns. A large part of these losses were contained within primary insurers’ catastrophe retentions, and therefore some cedents might consider purchasing aggregate, drop-down catastrophe covers this renewal season.

Competitive pressure continues to be the main driver for a decline in primary rates. Many players continue to attempt to maintain — and even increase — their market share, even though investment yields remain modest and individual catastrophic injury claims continue to increase in size.

Personal lines automobile coverage will continue to present a challenge both in Ontario and other jurisdictions. Current government reviews may results in further legal actions.

In this market environment, most local reinsurers will continue to focus on underwriting discipline and allocate their capital diligently. Overall, capacity for natural catastrophe programs is expected to remain stable, but rates in January 2010 may well be affected by the recent RMS model change.

In casualty, the potential risk from future inflation will continue to be an important discussion topic for Canadian reinsurers. If inflation accelerates over the next decade, claims inflation may exceed the assumed losses at inception. From this perspective, inflationary rate adjustments may be warranted.

6 Kenneth B. Irvin, President and CEO, Munich Reinsurance Canada Group

The worldwide banking crisis has largely passed, but what legacy of consequences will it bequeath upon generations to come?

Neither economist nor soothsayer has predicted a steady and healthy economic growth scenario for the globe in the foreseeable future. Instead, we have more doomsday-like prognostications of deflation, stagflation and hyper-inflation. Take your pick. They are all supported by wonderfully-crafted, credibly-supported jargon somberly presented in the Economist, Globe and Mail and their ilk. Somebody will get it right.

In the meantime, we have businesses to run and we must be ready to weather, ideally to prosper from, any economic environment that unfolds.

Prudential management, however boring that may sound, is the order of the day. This involves:

• getting the right price today for the risk assumed;

• providing solution-oriented customer service that exceeds expectations;

• accepting that investment yields will be negligible in the medium-term, while keeping the portfolio nimble enough and the duration short enough to avoid being trampled by runaway inflation;

• planning for claims inflation substantially greater than the cost of living; and

• managing expenses without cutting the heart out of the organization. We all have these challenges — reinsurers are no different. Those among us who rise to them best will prevail no matter the future.

7 Caroline Kane, Senior Vice President, Chief Agent in Canada, Toa Reinsurance Company of America

The Canadian insurance industry has seen underwriting profits diminish in almost all lines of business over the past two years. This can be attributed to several factors including inadequate pricing for the risk exposure and the increasing cost of inflation.

While reinsurers generally exercised more underwriting discipline over the past few years than the primary market, reinsurers’ results have also deteriorated.

It is important that reinsurers maintain underwriting discipline and focus on effective capital management in order to support the long-term viability of the Canadian reinsurance market.

While inflation is of concern to the industry as a whole, it is of increasing concern to reinsurers providing excess-of- loss protection on long-tail business.

Most auto/casualty treaty programs are placed on an excess-of-loss basis in the Canadian market with fixed retentions and limits; in other words, non-indexed covers. This means reinsurers must effectively price the product today, even though most losses will not be paid until several or more years in the future. Thus social, medical and legal inflation must be factored into the cost of writing long-tail business. While inflation is not something new facing reinsurers, it is exacerbated by current economic conditions and low investment returns.

8 Henry Klecan Jr., President and CEO, SCOR Canada Reinsurance Company

I don’t believe there is one, single most important issue facing the Canadian reinsurance community. There are several, varying in degrees of importance. They include:

• Potential legislative changes in Alberta that would prohibit the exclusion of fire following terrorist acts. These changes may undermine the solvency of insurers due to the uncertainty they create about whether or not the international reinsurance community would respond to fulfill its traditional role of risk mitigator.

• The growing divergence between the insurance and reinsurance markets. On the one side, we have the reinsurance industry, which operates on a business-to-business (B to B) model, looking to strengthen its technical margins, including prudent usage and allocation of its capital. On the insurance side of the ledger, competition for market share continues to dominate, resulting in downward pricing trends, with an expectation that reinsurers will follow the primary insurance market’s (mis)fortunes. But will they? And if so, until when?

• There is a wave of change under way for reinsurance providers and reinsurance buyers, considering the effect that the financial crisis has had on several reinsurers’ balance sheets. Reinsurance buyers are becoming more cautious when choosing the partners with whom they trade. Will buying decisions continue to be treated as a budget consideration, or more as a strategic consideration?

9 Cam MacDonal d, Chief Agent for Canada, Transatlantic Reinsurance Company

Emerging trends suggest one of the most important issues facing the Canadian reinsurance industry is the increase in large weather-related losses.

The frequency and intensity of events such as tornados, hail storms and rain storms appear to be on the rise. Climate change data indicates the average temperature over Canada has increased more than one degree Celsius and national precipitation levels have steadily increased. Warmer springs and summers, along with more moisture in the lower atmosphere, give rise to damaging, weather-related events. Heavy rains causing city street flooding, sewer overflows and flash floods are expected to be more prevalent during the next decade. Severe winter storms in the northern hemisphere have nearly doubled since the mid 1970s.

Certain socio-economic factors, including the appreciation of property values and ever-expanding populations, only increase our exposure to these frequent and severe weather-related phenomena. Recent changes to catastrophe models suggest future losses may be even larger than originally anticipated. However, as we become more reliant on computer models for assessing catastrophic risk, it is imperative that we do not become overly reliant on these model-based risk management tools. Scientific research suggests multiple severe weather-induced events are a genuine concern; they should be contemplated by risk managers when assessing potential aggregate loss scenarios.

Using all available data and every model at our disposal is helpful in understanding expected loss costs. However, let’s not forget to use one of our most important tools, a modicum of common sense.

10 G.S. (Steve) Smith, President, Farm Mutual Reinsurance Plan

When I was asked to provide my views on the single biggest issue of concern to reinsurers, loss severity trends immediately jumped to the forefront. Over the course of the past two years, we have seen five or six judgments handed down in excess of Cdn$10 million — the latest being the 2009 MacNeil v. Bryan decision, which topped Cdn$18 million.

As a result of this concerning trend, reinsurers are facing several significant consequences, many of which have not yet been fully realized.

The first and the most obvious consequence is the cost impact on the insurance system. This includes the financial impact of these decisions cascading down upon primary insurers, the burden of which will inevitably be shared with policyholders, the buying public.

The second issue, which I believe will lead to the most volatility, is the exposure that exists in open claims that have yet to be recognized and properly reserved. I believe a significant premium deficiency exists in the system that will need to be addressed.

Lastly, there is an emerging need to provide higher liability limits as a matter of course. This means convincing policyholders that they will need to further increase their own insurance costs for added protection. The standard approach, which is to provide Cdn$1-million limits, is reaching a point at which it is no longer prudent. Reinsurers will need to respond by providing the required casualty capacity, with the new norm being Cdn$5-million or Cdn$10- million limits for standard personal lines policies. In concert with the demand for higher limits will be the need to ensure adequate pricing, recognizing this additional exposure.

Unless there is significant reform to the Ontario auto product, including both accident benefits and tort, there isn’t any relief to this escalation in sight.

11 Matt Spensieri, Vice President, Chief Agent for Canada, General Reinsurance Corporation

The single most important issue for the reinsurance industry in Canada is adaptability — that is, “managing change.” Regulators around the globe have been working for some time to harmonize both regulations and their oversight of the financial services industry. This work will continue, and some of the regulatory changes will begin to take effect/have an impact during the next 12-18 months.

It goes without saying that reinsurers will need to understand and adopt Canadian regulatory changes. However, more than ever, they also need to understand changes taking place in other jurisdictions. These changes may influence how some clients assess, manage, report or protect their risks or assets.

We are all witnessing a trend of companies creating the position of “Chief Risk Officer,” either on a local or global basis. In most cases, the main responsibility of the chief risk officer will be to understand the risks that a company has assumed and then determine the most efficient method of ceding the “risk/exposure” that they choose not to retain. This sounds vaguely similar to what companies or the person in charge of ceded reinsurance currently does, but the bar has been elevated.

As changing regulations permit, we will likely see a move to free up capital and use it more effectively on a global basis. This will no doubt impact current local reinsurance buying habits, structures and products. For other than truly Canadian insurers, we may see:

• more “parent” assumption of risk;

• more pooling of exposures/risk with other jurisdictions; or

• more sophisticated products such as CAT bonds or other forms of securitization prior to cessions to reinsurers (and to those not necessarily located here in Canada).

Looking back over the past 30 years, most Canadian-domiciled insurers ceded business to “local” reinsurers, and mostly on a proportional basis. In pure dollars ceded, over time, the premiums have reduced as the market moved mostly to excess of loss. Precisely what the future will bring is unknown, but reinsurers will have to adapt to survive.

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Correction/Apology

Canadian Underwriter incorrectly published material attributed to PartnerRe chief agent Francis Blumberg in the cover story of its November 2009 reinsurance edition.

Blumberg’s correct submission (reproduced below) was submitted for publication in Canadian Underwriter’s 2009 November reinsurance edition.

Due to an error in Canadian Underwriter’s publication process, Blumberg’s submission for the 2009 edition was in fact substituted with his submission last year for the 2008 reinsurance cover story.

Canadian Underwriter is extremely embarrassed by this error and fully regrets making it. We offer our deepest apologies to Francis Blumberg for any confusion, as well as for the inconvenience he may have experienced arising from our mistake.

Also, in the same cover story, a submission by Caroline Kane, senior vice president and chief agent in Canada for the Toa Reinsurance Company of America, was regrettably omitted.

We reproduce Caroline Kane’s submission here in its entirety, along with sincerest apologies to her as well for our error and oversight.

The corrected copy for the November 2009 cover story is as follows:

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Many players continue to attempt to maintain — and even increase — their market share, even though investment yields remain modest and individual catastrophic injury claims continue to increase in size.