Volatile Calm

Here at home, there is concern over factors such as the apparent increased frequency and severity of extreme weather events, continuing consolidation and pressure on local reinsurers to achieve profit from underwriting results, not investment income. Couple that with a jumble of influences beyond Canada’s borders – the Euro area debt crisis, flagging growth in some emerging markets and regulatory demands – and domestic and global forces could conspire to bring the relative calm to an end.

Will it be a matter of clear skies ahead? Or are there indicators that storm clouds are forming? Is the current view of Canada as a stable marketplace enough to weather storms that may develop? How important will it be for Canada to exercise underwriting discipline, obtain adequate rate for the risk return and ensure that policy terms are commensurate with exposure?

Canadian Underwriter asked Canadian reinsurance company CEOs, presidents and chief agents what they expect to see on Canada’s reinsurance radar in 2013? Their answers are presented in alphabetical order by name.

1

Andre FredetteSenior VP & Chief AgentCaisse Centrale de Réassurance

The reinsurance market survived the financial meltdown of 2008-2009. I see no reason there will not be an orderly renewal season for 2013. There are, however, certain trends that are putting pressure on local reinsurers.

Low interest rates on government bonds mean that profit must come more from underwriting results rather than investment income. That said, the local insurance market is having trouble growing. Every company cannot meet its 10% growth target when the economy is only growing at 2%.

As a result, companies that have excess capital and pro rata treaties with reinsurers have used their excess capital to either reduce or cancel their pro rata cessions to reinsurers.

The result for a reinsurer, apart from lack of growth, is to make its portfolio mainly an excess of loss or Cat portfolio. This portfolio is inherently more volatile in results since the large pro rata treaties in the past tended to be low in volatility and helped to dampen the swing in results.

For 2013, the chief impact on primary insurance companies will probably be on the property per risk and catastrophe treaties since the results for these treaties have been poor in the last couple of years in Canada and also because of the fallout from the Cat losses in Asia (Japan, New Zealand and Thailand) last year.

Reinsurers are more likely to raise prices on renewal and to be more discriminating with regard to their use of capacity. Even primary insurance companies are taking similar actions, especially in quake zones such as Vancouver.

The other classes of reinsurance should be renewed on an “as is” basis or with minor increases, depending on individual results, but not at levels that would be described as disruptive.

2

Caroline KaneSenior VP & Chief Agent in CanadaToa Reinsurance Company of America

While the Canadian reinsurance industry showed a marked improvement in the first half of 2012 over 2011, the second half will likely show some deterioration, primarily as a result of catastrophe activity in Alberta, Saskatchewan and Ontario.

Despite the continued downward pressure on profitability – exposure growth, loss trends and low investment returns – there remains ample capacity in the Canadian market to foresee a fairly flat 2013 treaty renewal season.

The “pie” of available reinsurance premiums continues to shrink as primary insurers become larger, consolidate and retain more risk. Further consolidation within the Canadian market is expected to continue.

It is perhaps, in part because of this shrinking of assumed reinsurance premiums, that some reinsurers have diversified by becoming active or increasingly active in the primary market.

While Canada has been spared many of the financial meltdowns that have occurred in Europe and the United States these past few years, Canada nevertheless operates in a global economy. We are not immune and cannot operate in isolation to events happening beyond our borders. The industry at large will continue to be faced with numerous challenges, including what seems to be an increase in frequency of weather-related losses, changes to the political landscape and continued economic uncertainty.

Overall, capital needs have increased and will continue to do so in this dynamic environment in which our industry operates. The “flight to quality” remains paramount to insurers, reinsurers, regulators and rating agencies alike.

To face the current and future challenges as reinsurers, it is necessary to remain focused, exercise underwriting discipline and obtain adequate rate for the risk return.

3

Sharon LudlowPresident & CEOSwiss Re Canada

The global economy remains fragile, with Europe in recession and weak growth in Canada, the United States and Japan. Even the emerging markets are growing at a reduced pace.

The Euro area debt crisis is subdued for now, but is far from being resolved, creating uncertainty all around the world. Moreover, currently, the potential for the U.S. economy to go over the fiscal cliff adds another dimension to political-induced uncertainty.

Slow growth and stimulative monetary policies have kept interest rates low and has property and casualty insurers focused on underwriting profitability. Insurers are also “re-risking” their investment portfolios, seeking higher returns as they continue to earn dwindling interest rates on “safe” government bonds.

The focus on underwriting profitability and the increased use of predictive analytics is expected to continue. Generally speaking, primary property insurance prices are trending upwards; commercial pricing is lagging behind.

Globalization has brought foreign Cat risks close to home. The Japan earthquake and the Thailand floods of 2011 revealed increasing global vulnerabilities to supply chain disruption and related business interruption exposures.

Diversification, stability and a strong capital position are critical in a global reinsurance market. The (re)insurance market in Canada has weathered storms before and should continue to do so in 2013.

Looking ahead, the overall market environment remains challenging, but there is economic rationale for continued improvements in pricing and the prospect for higher investment yields further down the road of economic recovery.

4

Cam MacDonaldSenior VP & Chief AgentTransatlantic Re

Recent history has again confirmed that large weather-related losses – such as the Calgary hailstorm this August – are here to stay in Canada. And the Canadian reinsurance market should anticipate more of these catastrophic events over the upcoming 12 months.

Changing weather patterns, population density and higher property values have conspired to create a wide array of potential loss scenarios throughout the entire country (remember Slave Lake).

Writing on Halloween eve, it is scary to imagine that if the stars were aligned a bit differently, the recent combination of Hurricane Sandy and the 7.7-magnitude earthquake off the coast of British Columbia just days apart, could have been the realization of our industry’s “worst case” scenario.

It appears, at least this time a round, that we dodged a potential loss sequence of biblical proportion. Indeed, this double near-miss should serve as a wake-up call to all reinsurance underwriters.

Despite these warnings, there remains a plethora of available global capacity and appetite for Canadian Cat business as many international underwriters view Canada as a preferable non-Cat-prone zone.

However, as Canadian catastrophe loss analysis evolves, it is expected that greater emphasis will be placed on loss frequency and severity in pricing models. In a weak investment environment, there is considerably more pressure on underwriting profit and it is imperative that policy terms and conditions are commensurate with exposure.

Canadian regulators have made earthquake aggregation and capital requirements a top priority and as we draw closer to the 1 in 500 year event threshold, the focus on this subject will intensify.

5

Frank RueckertSenior VP, Canadian Treaty DepartmentHannover Re

Despite the hail that accompanied the Alberta storms in August – with a market loss estimated at $400 million to $600 million – 2012 has been marked by an absence of big Cat losses. Some individual programs affected by losses may see property Cat rate increase, although unlikely across the board or at the levels at 2012 renewal. Global developments and severe losses in Canada during a tough 2011 motivated significant premium hikes and some markets to reduce their capacity.

On the casualty side, reinsurance rates are not where they should be. However, with consolidation, the very biggest primary players in the market can afford to retain more of their business, making it less likely it will be ceded to reinsurers.

With the Office of the Superintendent of Financial Institutions making changes to how property and casualty insurers measure and manage earthquake exposure, B.C. quake is certainly an issue and cedents may respond by adjusting their writings and, possibly, their exposure. As well, the multitude of severe losses in Alberta will need to be monitored to determine if this is part of a trend.

Looking forward, reinsurers will also likely keep an eye on the concentration of cedents in some regions. Are we happy to live with concentration that would mean being just as exposed in the future to certain kinds of losses as has been the case in the last 18 to 24 months? From the reinsurance perspective, is it advisable to take on more business if a reinsurer is too heavily concentrated, independent of the possible margin?

There is also the ongoing consolidation process between primary companies, primary companies buying brokers and brokers buying brokers. This can possibly produce a situation where reinsurers do not see the bread and butter business, but are increasingly pushed toward the high-volatility Cat layers, which carry high capital charges.

6

Steve SmithPresident & CEOFarm Mutual Reinsurance Plan

While the unprecedented global catastrophe activity from 2011 took a very positive turn in 2012, the catastrophe activity in Canada continues to prove somewhat volatile.

Occurrences such as the August hailstorm in Alberta, the severe thunderstorms that struck several areas of Ontario – including Hamilton, the Greater Toronto Area and Thunder Bay – and the windstorms that frequented Western Canada were not insignificant.

In addition to the loss activity, the outlook for investment returns (arguably) for the foreseeable future remains relatively dismal. With the risk-free rate of return down to approximately 1.5% and investment returns barely above that, the pressure for rate adequacy at the reinsurance level will be very evident. The cost of capital will ensure that reinsurers emphasize minimum rates on line to at least maintain and achieve desired returns for their shareholders.

Exposures in earthquake zones that are now subject to both additional regulatory reporting and capital requirements will place further emphasis on Cat modelling and data integrity in 2013.

Primary auto rates will see some reductions or, at best, remain flat as insurers are experiencing a marked improvement over 2011. This will likely generate upward pressure on reinsurance rates to maintain income levels as loss trends are reflecting a rise in severity, particularly with the increased exposure to Catastrophic Impairment rulings on Ontario accident benefit claims.

However, this will be somewhat conditional on a couple of fronts. The ability of insurers to increase retentions and absorb more risk, coupled with evidence of reserving adequacy and limited adverse development, will be significant factors.

In spite of the pressure to generate decent returns, the Canadian reinsurance market continues to be well-capitalized, providing the ability for reinsurers to grow. Any growth opportunities that will be identified will be met with the challenge of achieving adequate rates in a very competitive marketplace.

7

Matthew SpensieriVP, ReinsuranceCatlin Canada Inc.

While there are numerous and significant influences on the reinsurance market, the most obvious/recognizable driver is catastrophe loss(es) or the absence thereof. In 2011, the industry suffered both a high frequency and high severity of losses around the globe. These events prompted a slight restriction in capacity, along with a minor uptick in pricing at year-end.

Thus far in 2012, there have been very few “events” around the globe. To date in Canada, we have seen a number of events, although most have been relatively minor. The largest was the August hailstorm in Alberta, with estimated losses being as high as $600 million.

While the Cat losses suffered in 2012 by insurers and reinsurers in Canada are sizeable, they are not anticipated to cause significant disruption. Apart from “adjustments” to specific programs that may have suffered a loss, little change is expected for the coming year.

Model changes and regulatory requirements may continue to fuel demand for Cat capacity. We have also witnessed industry consolidation influencing demand, at least until the combined portfolios can be ratified.

That said, there appears to be ample capacity available for Canadian companies either in traditional Cat covers or in a growing availability of “insurance bonds” or other risk transfer vehicles.

However, the main influence of this supply/demand marketplace is price. The current low interest rate environment, coupled with the economic downturn from 2008, has caused many reinsurers to be more disciplined/protective of their capacity (capital).

At the “right” price, they are willing to assume risk. Otherwise, they are less willing to risk their capital, especially at these low investment yields levels.

The recent 7.7-magnitude earthquake in British Columbia produced little resultant loss. At the time of writing, Canada was feeling the impact of Hurricane Sandy as it reached the United States, having left a swath of destruction in the Caribbean. While the losses in Canada from this storm may be “modest,” the ultimate total cost to the worldwide insurance/reinsurance industry will definitely be in the billions.

From an economic, regulatory and business perspective, Canada is seen as a very stable market. While we continue to experience Cat losses, there is a belief that failing a “mega catastrophic event here in Canada” – which some are predicting, but no one is actually wishing to occur – not much will change over the coming year.

8

Matt WolfeSenior VP & Managing Director CanadaBeach and Associates Ltd.

The Canadian reinsurance market outlook for 2013 is likely to be a “tale of two cities.” The story will feature a growing and stable property marketplace (particularly property catastrophe) set against a casualty marketplace that continues to shrink, likely to the ultimate detriment of reinsurers and insurers alike. Property catastrophe reinsurance demand is robust and will continue to be so in 2013 as insurers move towards meeting the Office of the Superintendent of Financial Institutions Canada’s ultimate goal of having the financial resources (capital and reinsurance) sufficient to meet earthquake claims equivalent to a 1 in 500 year event.

Reinsurance supply will be sufficient to meet demand next year and pricing is expected to be generally stable. Insurers may see reinsurers push for some rate increases in light of their recent losses from Hurricane Sandy, especially if that event quantum continues to increase. That said, any such increases are likely to be modest.

While the Canadian property catastrophe reinsurance market is currently meeting the needs of Canadian insurers at a reasonable cost, the recent 7.7-magnitude earthquake in the waters off British Columbia is a useful reminder that this could change.

Canadian insurers should build contingency relationships with non-traditional suppliers of property catastrophe reinsurance capacity (capital markets) to have alternatives at hand in the event of a major catastrophic event. These relationships will also be a useful supplement to traditional reinsurance capacity as the movement to the 1 in 500 year event threshold puts some pressure on reinsurers to meet demand.

The Canadian casualty reinsurance marketplace has been contracting in recent years and this trend is expected to continue through 2013 unless one or more of the following three factors plays out:

1) a major catastrophic event materially reduces insurers’ available capital;

2) a major casualty systemic event occurs; or

3) reinsurers find a way to evolve their casualty reinsurance product offering to recapture lost business.

Reinsurers need to balance their property catastrophe exposures by writing casualty exposures. Unless one of the aforementioned three events occurs, the continued contraction of the casualty reinsurance market will likely result in more reinsurers entering the casualty insurance sector and diluting returns for all.