The “REAL DEAL”?

Not unlike the frustration and confusion expressed by the investment markets during the inconclusive and back-biting legal play that ended the race for of the U.S. presidential election, Canadian primary insurers have waited with baited breath from the middle of this year as the 2001 reinsurance treaty renewals approached. The cause of the market’s apprehension relates to the hard-hitting reinsurance rate adjustments that occurred in Europe and the U.S. at the half-year mark of 2000 (although most treaty renewals are handled at the end of the calendar year, there are a significant number in Europe and the U.S. which are negotiated with effect from the end of June). Some cover layers in European markets went up by 200% and the U.S. market saw some broad commercial covers attract rate hikes of between 25% to 50%. Heavy European storm losses, combined with what most insurer CEOs readily admit to having enjoyed “under-priced” reinsurance coverage over recent years, particularly under the guise of Y2K-motivated multi-year programs, were expected to result in dire price demands at the upcoming treaty discussions for 2001.

Although these treaty negotiations have historically occurred in December and lead into January, with terms agreed taking effect from the beginning of the new calendar year which is also typically the new financial year of most insurers, these discussions have been entered into at a much earlier point over recent years – no doubt a reflection of the intense competition which has produced almost criminally low rates relative to underwriting performance. The fact that CU has not picked up on any high-pitched yelps of indignation or saber-rattling by insurer CEOs, would seem to suggest that the rate negotiations thus far have been of a cordial nature and reached a fair conclusion – which would support the views of many reinsurance CEOs who contributed to our annual “rate wrap up” preview (see cover article of this issue for further details) in suggesting that Canadian adjustments will be moderate and determined according to individual experience.

However, the question that many within both primary insurer and reinsurer ranks are still asking is whether the rate turnaround predicted to take effect next year is indeed the “real thing”. As Gerald Wolfe, chief Canadian agent for GeneralCologne Re remarks, “the reinsurance market has been too soft for too long. Corrections are on their way. However, the question remains as to whether they will be sustainable over time”. Rhine Re’s Canadian chief agent Patrick King also observes that both the Canadian primary and reinsurance markets continue to suffer from excessive over capacity in capital. He notes that the primary market is estimated to be operating at only about 42% of writing capacity and reinsurers are believed to be in even worse shape. So, against this backdrop, can market participants really expect a rate hardening for next year?

“Yes, rates will harden next year,” is the emphatic response of every reinsurance CEO responding to our annual rate preview article. However, although most agree that rates are at extremely low levels and therefore ideally call for drastic adjustment, the type of action likely to be taken is moderation with a “best case” scenario of upward increases of between 10% to 25% depending on the business line and client experience. Most of the CEO respondents also believe that the rate adjustments coming will have to be handled over a period of time, probably over two to three operating years. But, they remain adamant that a positive correction in pricing will begin next year, which should ideally feed through to primary company pricing.

Having reviewed reports from Canadian reinsurers, as well as monitoring the actions taken in the U.S. and Europe, I would tend to agree that insurance prices will begin to firm next year – beginning with a more firm stance on the reinsurance front. However, will price adjustments reflect a return to “adequate underwriting” – I do not believe so. The excess capital in the market combined with growing outside competition for the “risk dollar” will temper the potential of pricing adjustments according to historical levels of what was seen to be “operationally acceptable”. The real ailment facing the insurance industry is that the rules of the business world have changed, and the marketplace will simply not accept what is regarded as “inefficient pricing”. To deal with this environment, insurers and reinsurers will have to adapt their business strategies to become more competitive, and if this means vacating certain lines of business, then so be it.

At any rate, the short-term picture would indeed support the view that higher reinsurance pricing will kick off the 2001 financial year – if for no other reason than the “insurers” to reinsurers, the retrocession companies, were severely burnt by 1999’s underwriting experience, and subsequently several high-profile players have withdrawn from the business while the remaining contenders have hiked pricing significantly. The fact is, most reinsurers observe, with the current adverse state of the market this cost will have to be passed on to insurers.