Tipping Point?

Players in Canada’s reinsurance space are expected to see some familiar faces yet again in 2016. Many of the same market influences in recent years – low interest rates, mergers and acquisitions activity, the influx of alternative capital, more than ample supply, wide buyer choice and rates some argue have bottomed out – are expected to persist in the coming year.

These conditions have, no doubt, applied pressure on reinsurers over the last few years, but as 2015 turns into 2016, that pressure seems to be just a bit stronger, just a bit more present.

Loss events have occurred, but the natural catastrophe experience to date in 2015 has looked very much as it did in 2014. It has been fairly quiet, bringing with it, at worst, the potential for complacency, but, at best, an opportunity for different players to rethink what they can do on their own and when it is better to partner to guard against the losses that inevitably will come.

Is it possible the reinsurance market, while still strong and many players are still performing well, has reached its tipping point? Will current conditions allow buyers to begin investigating alternative structures and additional limits? Will new and innovative offerings, coupled with well-tended relationships, allow reinsurers to better deliver on their value proposition? Or will those in Canada’s reinsurance industry simply maintain their share and prepare for another year of more of the same?

Canadian Underwriter asked senior executives of reinsurance companies operating in Canada what they see ahead for 2016. What effect will these persistent conditions have on reinsurance market here at home?

1 Donald P. CallahanPresident & Chief Executive Officer Guy Carpenter Canada

At this time last year, it appeared that reinsurance pricing had reached its historical low. Some buyers took advantage of the sale prices, but, paradoxically, most bought less reinsurance in order to promote net premium growth.

Local reinsurers were perplexed. They were clearly selling a product at or below cost and yet there were very few takers.

Today, the landscape is unchanged in the virtual absence of major catastrophe losses. Because Cat activity is low, Canadian-licensed reinsurers will likely post a sub-80 combined ratio for 2015. Premium is flat or down. The local reinsurance underwriters are fighting for scale, with supply (capital) far outstripping demand.

At this time last year, there was a sense that buyers would logically go on a spending spree with new quota shares or drop down contracts in view of the fact that the cost of reinsurance was approaching negative territory, with quoted premiums sitting at levels at or below projected recoveries. New deals, however, did not materialize.

Today, everyone on the sell side is still ravenously hungry. The reinsurers are more focused on their insurance businesses and are actively competing with clients.

Furthermore, an inevitable diminution of distributors is looming as the smaller reinsurance brokers operate at a loss. Brokerage revenue is not covering expenses for these firms and their future in this constricted market is very much at risk.

With the exception of new and sophisticated methods for modelling and reinsuring the flood peril, the 2016 reinsurance outlook is simply more of the same. Pricing will drop another 5% to 10% on a risk-adjusted basis. Insurers, preoccupied with top line, will forgo the financial benefit that inexpensive reinsurance provides. Reinsurers will reluctantly authorize despite their technical indications.

2016 will be the year of the bargain, but most of the available products will remain on the shelves.

2 Pierre Dionne Senior Vice President & Chief AgentCaisse Centrale de Réassurance – Canada

2015 is turning out to be another quiet year on the natural catastrophe front, both worldwide and right here at home. But this does not mean the year is boring. Quite to the contrary!

The industry has been abuzz with news of mega-mergers, such as Ace and Chubb, XL and Catlin, Endurance and Montpelier, just to mention the ones with some impact on the Canadian marketplace. Asian insurance companies are also purchasing western companies, expanding outside of their borders. And then there were the mergers that never came to pass, which shall remain nameless.

The reinsurance industry can expect the mergers and acquisitions (M&A) trend will continue into next year, and the next global deal may have bigger repercussions in Canada.

Additional M&A activity specific to the Canadian insurance marketplace is also expected, resulting in a shrinking reinsurance pie, and downward pressure on reinsurance prices over the coming years (barring major loss activity).

Not everything is looking down, though. Some insurers have started offering flood insurance for homeowners in Canada, increasing the relevancy of the insurance industry to its customer base. At the same time, this will generate new premium for the industry. Insurers should be mindful that a solution must be found for the high-risk houses, which require flood insurance the most.

There is also a large earthquake coverage gap, especially in Québec, which will eventually need to be addressed.

The insurance industry must also remain relevant on the commercial front, finding innovative solutions for the top risks faced by corporations, such as reputational risk and cyber risk.

Only by providing coverage that is meaningful to its customer base, with the support of their reinsurers, will the industry manage to grow premium by more than the gross domestic product, and at the same time start increasing the size of the reinsurance pie.

Bon appetit!

3 Tim FisherCanadian Branch ManagerXL Catlin – Reinsurance

How will the market for Canadian reinsurance business evolve in 2016?

To answer that question, it may be best to consider if the major trends from 2015 will persist.

• Mergers and acquisitions activity: Major forces in today’s economy such as globalization, better data and analytics and increasing regulation all signal increased scale being critical to future success. Combined entities should be better positioned to entertain any risk a client has, fostering enhanced client and broker relationships. M&A activity is expected to continue through 2016.

• Available capacity: The combination of low loss activity and alternative capital entering the reinsurance market has resulted in elevated supply from sellers. From the buy side, consolidations, increased retentions and pressure on margin have resulted in relatively consistent buying requirements. This, too, could persist into 2016.

• Pricing expectations: There are signs the property Cat market is starting to reach a floor, driven by rates no longer being proportionate with the risk. Rate declines have slowed, pricing in the insurance-linked securities market is stable and, in some markets, some placements have been re-priced. Pricing in the casualty segment remains under pressure, primarily as a result of increased supply from reinsurers and a reduction in demand following significant increases in program attachment levels in recent years. Given current reinsurance retention levels, buyers have very significant exposure to changes in loss frequency and severity. Pricing metrics point to the need for pricing stability and slowing of price declines is expected.

• Reduced reinsurance panels: Outside of Canada, there has been a move from buyers to reduce their panel of reinsurers. In general, buyers want to work with reinsurers that can engage with them globally. This trend appears likely to impact Canadian placements more over the next few years.

• Traditional reinsurance market: To not only survive, but thrive, reinsurers must strive for analytical excellence and innovate for risks with respect to risks that are underserved.

• Relationships central: As always, relationships will remain critical in allowing reinsurers to trade through the cycles inherent in this business.

4 Jean-Raymond Kingsley Chief Agent & Chief UnderwritingOfficer – Canada Odyssey Reinsurance Company

The Canadian reinsurance market is facing numerous challenges as 2015 comes to a close. While it may be a bit early to comment on January 1 renewals, there are several factors that will continue to impact the market in 2016.

Clearly, consolidation will continue to reign for the foreseeable future. Mergers and acquisition activity has been consistent and its ultimate effect appears to be a reduction in the amount of business ceded to the reinsurance market.

It will be interesting to see what the reinsurance landscape will look like when the current wave ends. There will probably be fewer players, but new participants will emerge over time in response to market opportunity.

The market is also seeing the impact of globalization, whereby some programs that were historically placed in Canada are now part of a global or North American placement.

As well, the impact of the Office of the Superintendent of Financial Institutions Canada’s B-9 Guideline: Earthquake Exposure Sound Practices has not fully materialized. While the guideline was anticipated to encourage an increase in the level of coverage purchased by primary companies, reinsurers have instead seen that some companies are buying less Cat coverage.

Overall, the net effect of these factors is a reduction in business placed in Canada.

While size and business diversification are helpful in a declining market, Canadian reinsurers with long-standing market relationships, financial security and a desire to be innovative will see a good share of opportunities in 2016.

Despite an overabundance of capacity putting negative pressure on rates, reinsurers are seeing some signs around the world that the significant rate reduction experienced during the last two years is slowing down.

Needless to say, this firming of the market would be a welcome change not just for catastrophe placement, but across all lines of business.

5 Geoffrey Lubert Executive Vice President & Managing DirectorWillis Re Canada

Canadian insurers purchasing reinsurance in 2016 will continue to benefit from the conditions of a buyer’s market.

Reinsurance capacity remains plentiful and there is a significant portion of the market providing upper level catastrophe capacity at rates on line below 2.0%.

With a few exceptions, large global insurers continue to consolidate their various regional reinsurance programs into one purchase, thereby exacerbating the impact in Canada. These conditions put further pressure on reinsurers in this market.

Mergers and acquisitions will continue as companies strive to achieve better scale in a challenging marketplace and satisfy their capital providers and shareholders with improved returns on investment.

XL and Catlin, Endurance and Montpelier Re, Willis and Towers Watson, and MS Frontier and Amlin Syndicate are recent examples of completed and pending deals. Despite a long engagement, the proposed marriage of AXIS Capital and Partner Re did not make it to the altar. In addition, only a handful of Lloyd’s syndicates remain truly independent.

Differentiation is the key to being prosperous going forward in this challenging market. Reinsurers will look to position themselves with clients and intermediaries by offering a value proposition that distinguishes them from their competitors.

Intermediaries with strong local investment will deploy their resources to develop and unearth products and opportunities, which provide new reinsurance premium to the market.

Analytics will continue to dominate the scene. Reinsurance buyers expect and deserve leading-edge analytical tools. The reinsurance intermediary will use these models to enable their clients to compete more cost-efficiently in their specific market.

Quite obviously, the natural hazard and weather models will assist insurers in better understanding their exposures and how to manage them. Recently, there have been examples where clients can better deploy adjusting staff following events, resulting in cost savings and enhanced reputations with their insureds.

Soft markets are challenging for all the participants, but with strong broking teams, compelling analytics and technical partners, everyone can flourish.

6 Cam MacDonald Senior Vice President & Chief Agent – CanadaTransatlantic Reinsurance Company

The Canadian reinsurance market continues to struggle under the weight of a plethora of readily available capacity from a variety of traditional and non-traditional sources.

Achieving technically adequate pricing of risk is proving difficult, and far too often in today’s competitive environment, it is a matter of to what degree the reinsurance market is prepared to discount rates in order to write new business or to maintain existing accounts.

The fact is that some accounts contain little or no profit margin. Couple this with an end to favourable reserve and IBNR (incurred but not reported) adjustments, as well as a woefully low interest rate environment, and it is easy to speculate that more pressure will be applied to underwriting result sooner rather than later.

However, if the soft market persists, there is little doubt that more reinsurers will fall by the wayside because of poor results or through acquisition.

In addition to ongoing market challenges, reinsurers must also deal with managing new and emerging exposures such as telematics, drones, cyber and flood coverage on homeowners’ policies.

These exposures are not something far off in the future; they are here now and new analytics and risk management techniques will be required to properly assess and diagnose these new risks. Telematics will radically change the (re)insurance industry’s perspective on automobile insurance, cyber coverage presents a host of security issues, drones will create privacy concerns and potential hazards for the airline industry, while flood insurance on personal property will be an enormous undertaking.

On a positive note, these emerging risks offer tremendous opportunity for the reinsurance marketplace, although with any peril, it is incumbent on the underwriting community to accurately assess these risks and properly price products – hopefully, something seen more often in future.

7 Frank RückertSenior Vice President, Canadian Treaty DepartmentHannover Re

Not much change in pricing is anticipated for the upcoming renewals, and in the absence of really major losses to the market, this trend will continue.

Reinsurers in Canada are still in the phase of recouping from the losses incurred in 2013.

It is critically important that reinsurers differentiate themselves and show their value as fully fledged reinsurance companies, particularly in light of the fact that more and more capital is coming into the market and the sources of that capital are not necessarily looking at the long term.

Clients have to make forward-looking, but still economical, decisions. In response, reinsurers must determine at what portions they can deliver value over and above a competitive rate. They must be solution-oriented, quick, understand the customer’s problem and start thinking more in three- to five-year horizons than be focused on a specific return on equity for a single year.

The challenge: this approach requires a client (primary insurance company) that thinks (can afford to think) the same way.

The game that investors play is black and white: either there is a Cat and they decide to double down or walk away, or there is no Cat and they book the money and do it all again next year. Reinsurers must ensure that that perception does not apply to the reinsurance market as well.

With the continuing mergers and acquisitions activity and some primary companies choosing to retain one or the other bottom layer themselves, the reinsurance market as a whole will not increase from a premium perspective.

Reinsurers have to be innovative and, together with the broker and client, determine what helps the client and how programs can be constructed to make more sense for that client. Possibilities include providing multi-year deals and deals across all lines.

Talk is continuing around flood and cyber, but the reinsurance industry is in a wait-and-see position.

8 Veronica Scotti President & Chief Executive OfficerSwiss Re Canada

From boardrooms to the boulevards, sweeping transformation is challenging the (re)insurance industry to maintain its essential function in the economy. It would be nice to think the industry has finally acknowledged the challenge and is readying for it.

Ridesharing is transforming the streets, changing how the (re)insurance industry thinks about mobility and the risk it brings. The emergence of Uber forces insurers to rethink their assumptions about auto liability – leapfrogging everyone into the imminent reality of granular data-based underwriting.

The competition is good for consumers and it creates jobs – but it puts on the road a type of risk that is different and unfamiliar.

Autonomous cars will also change the risk equation, forcing insurers to contemplate a host of new probabilities when technology takes the wheel.

The next time floodwaters overtake a community, it is hoped that more citizens will have the funds to recover and rebuild. Private carriers are increasingly offering overland flood insurance thanks to improved models and a collective resolve not to repeat the hardships of 2013.

However, it will take a collaborative

effort between public and private sectors to close Canada’s $2.1 billion property protection gap, much of it due to flood exposure.

As brisk mergers and acquisitions activity continues, the task of closing that protection gap will fall to fewer, larger companies, who will also have to respond constructively to concerns about affordability, availability of coverage and societal expectations of being served in innovative and efficient ways.

Companies will have to consider the advantages and disadvantages of reinsurance solutions, alongside more traditional financing options. They will look to strike strategic alliances with those partners able to support their transformative journey beyond capacity offering.

The quiet evolution with the greatest potential impact is happening outside the public eye – but squarely in the regulatory spotlight – as insurers continue to embed enterprise risk management and Own Risk and Solvency Assessment throughout their organizations.

Reinsurers will undoubtedly play a key role, assisting clients with early identification of possible downside scenarios and modelling of solutions.

9 David Sloan Chief Executive Officer Aon Benfield Canada ULC

For this coming renewal, the expectation is there will be rate reductions of 5% to 10% (risk-adjusted).

With respect to reinsurance contract terms and conditions, there was broader coverage by way of an expanded loss occurrence definition on catastrophe treaties in 2015, changes tailored to meet the specific needs of each client.

For this renewal, it is anticipated there will be a harmonization in the loss occurrence definition used across the client base.

On the surface, 2016 could be seen as the typical soft market renewal: plentiful capacity, reducing pricing and expanded coverage. However, two things make this soft market renewal different:

• Alternative capital: It has had a profound impact on the global reinsurance market. It is estimated that almost 50% of the capacity for Florida wind originates from alternative markets.

Although not directly in use in Canada, the excess capacity created globally intensifies competition at the local level. As reinsurers continue to adjust to this new reality, it is expected that the push towards diversification to new lines of business and territories, either organically or through mergers and acquisitions, to continue. Reinsurers need scale.

• Flood coverage: 2016 should see the wider availability of the flood product to homeowners. However, since the release of these products is just getting under way, reinsurers are not yet in a position to reflect this exposure in their reinsurance pricing.

This being said, many would argue the overall exposure will be reduced relative to 2013 as the clarity of the actual coverage provided is improved at the policy level with the introduction of a definition of flood in the wording.

The challenges in assessing these new products going forward include the following:

1) differences in product offerings between insurers;

2) differences in underwriting stance between insurers (no-write zones? sublimits? deductibles?); and

3) take-up rates in general, as well as in high-risk versus low-risk zones.

10 Steve SmithPresident & ChiefExecutive OfficerFarm Mutual Reinsurance Plan Inc.

The Canadian reinsurance outlook for 2016 continues to be very optimistic as reinsurers enjoyed yet another quiet Cat year in 2015 and, fortunately, the United States hurricane season came and went with only a whimper.

The main focus for reinsurers heading into the new year is a collection of emerging issues and what these exposures represent to the reinsurance market.

Products are being developed to respond to overland flood, drones and cyber with very little credible data or underwriting experience to support confident pricing at both the primary and reinsurance levels.

There will be a great deal of interest in underwriting approaches, pricing and consumer response to these emerging risks as the reinsurance industry watches closely while the market evolves.

The soft reinsurance pricing appears to be subtly firming as reinsurers focus on underwriting profitability, recognizing that investment returns deteriorated through the third quarter of 2015.

The profitable results of the last few years have been supported by reserve releases which, obviously, cannot continue, meaning underwriting and pricing discipline will be clearly evident through the renewal season.

The one interesting event that has the potential to be a market-changing event, and yet to be fully understood, is the Volkswagen issue that has the potential to generate insurance/reinsurance losses well into the billions of dollars. The reinsurance community will be watching very closely.

The one challenge all reinsurers will be facing is achieving growth goals and mandates. The market is over-capitalized, with every reinsurer around the globe trying to grow and deploy capital, while at the same time, not sacrifice price and underwriting standards.

11 Eric SteenExecutive Vice President – ReinsuranceJLT Re

The stakes and risks associated with making the right decisions are arguably higher than in past periods as reinsurers and reinsurance brokers alike enter the busy “year-end” season for reinsurance buying.

Risks continue to be extreme for natural catastrophe-related exposures or individual risk selection elements, yet providers are competing for these risks in an environment with a very low rate of return.

Adding to the perils of obtaining adequate terms for the paper provided, these same insurers and reinsurers are looking to gain scale and top line premium by merging.

In addition, real interest rates in Canada and in similar economies have been near zero for some time, so access to funds to buy or consolidate will remain robust well into 2016.

Organic growth is also lackluster; yet adding growth, profitability and efficiencies remains a high priority.

Similarly, technology and distribution by the more tech-savvy competition will marginalize behemoths who are too slow to react and risk being left behind.

In 2016, the (re)insurance industry will continue to see the development of usage-based insurance and unmanned automobile technology, while unmanned aerial vehicle/drone commercial coverage will become a very hot and divisive coverage item.

Cyber attacks, terrorism threats and climate change will continue to be potential world-wide game-changers, while major natural catastrophes carry supply change impacts of their own.

Finally, global reserving – traditionally, the largest “catastrophe” facing the sector – may be coming to the end of a long period of redundancies, further pressuring underwriting capital.

The world of underwriting remains in an uncharacteristically long-term state of relative calm, which has benefitted returns on equity both for insurers and reinsurers.

However, the soft market is encouraging risk managers of all varieties – insurance companies, corporations and the government – to take a closer look at solutions, including alternative parametric based-products on a per-occurrence and aggregate basis, hedges for business interruption, community interruption, contingent business interruption and weather derivatives that may have appeared too expensive a few years ago.

With continuing increases in reinsurers’ reported balance sheet surplus, only a series of events, possibly involving catastrophe losses, reserving, interest rates, inflation – or all of the above – could make an impact on these results.

12 Phillipp WassenbergPresident & Chief Executive OfficerMunich Reinsurance Company of Canada

Every fall, reinsurers reflect about what to expect in the year to come. This year, it seems as if the future has already caught up with the industry.

The proclaimed change is no longer ahead, but all around – leaving reinsurers without the comfortable signposts that have been used in the past to determine where they are in the (re)insurance cycle. _Canada is no exception in this respect.

Not only do reinsurers continue to be pressured by low interest rates and an abundance of capital, there is also truly disruptive pressures from unanticipated sources.

Cyber exposures are growing so exponentially that reinsurers can hardly get their heads around defining, let alone ring-fencing, the risk and the accumulation. Shared economies alter or even eliminate the risks to be insured as reinsurers have known them. Automobile is at a crossroads as the automation of driving disrupts daily driving behaviour, and this is happening much faster than anticipated only a few years ago. New and applied technologies are redefining how to access clients – today in personal lines; tomorrow in commercial lines.

As more and more devices collect data (Internet of Things), reinsurers are asking how this vast amount of additional information will be used to supplement risk analysis. Big data analytics allow for an understanding of individual risk drivers to an extent unimaginable only yesterday.

As a market, are reinsurers ready to rise to these challenges? While some aspects of the insurance industry will remain traditional for some time, only rapidly developed custom or innovative solutions will ensure it is not “Uber-ized.”

Listening to client needs and offering full co-operation are required more than ever. As changes emerge, and innovation becomes commonplace, collaboration between primary risk carriers and reinsurers will have to extend towards innovation and digitalization.

From a Canadian reinsurance perspective, risk taking has just become more multi-dimensional.