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Reinsurance Outlook 2006 Post-Katrina


November 1, 2005   by Canadian Underwriter


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As we head to press, Hurricane Wilma has heaped an additional US$5 billion to $10 billion in losses upon what has otherwise already been a busy and costly hurricane season. For the first time ever, the U.S. National Hurricane Centre has dipped into the well of the Greek alphabet to name a weather event – Tropical Storm Alpha, which weakened and was subsequently absorbed by the winds of Hurricane Wilma.

Thus far, Hurricane Katrina has been the most destructive of all the hurricanes, dominating public discussions among reinsuerers throughout North America. The Category 4 storm – which damaged the New Orleans levee system and resulted in massive flooding – is estimated to have caused between $35 billion and $60 billion worth of insured damage. Hurricane Rita soon followed, causing a further US$4 billion to $7 billion in insured losses to Texas and the southern part of Louisiana. If you factor in early predictions of insured losses in Florida arising out of Hurricane Wilma, then all told the North American insurance industry is backstopping losses in the range of $44 billion to $77 billion for three hurricanes.

As we approach the renewal season, we have asked 11 CEOs of reinsurance companies to gaze into their crystal balls and predict how the industry will react to record-breaking catastrophic losses. Not surprisingly, their thoughts about 2006 provide a snapshot of the kinds of issues that face the reinsurance industry as it mops up after a particularly busy year. The need for diversification is cited, as is the need to review cat modelling – and yes, hard markets and rate increases are among the forecasts.

Pierre Michel Head of Canadian operations and chief agent of PartnerRe

The call for the reinsurance market to demonstrate security has never been more pressing. This is not to say the reinsurance industry needs to operate differently; rather, the insurance community and reinsurance brokers should discriminate clearly between reinsurers based on the reinsurers’ business models and risk management practices.

Look at how Katrina impacted various reinsurers, for example, as reflected in ratios that show a percentage of the loss to the mid-year capital base. The distinction is staggering between those that lost less than 15% of their capital, say, and those that lost anywhere between 25% and 45%. This speaks to how differently various players diversify their risks across types of perils and geographies.

Thankfully, access to the capital markets allowed capacity to be quickly – albeit partly – replenished. But it is essential to understand how reinsurers’ risk management and diversification policies impact sustainable value creation for the ultimate benefit of clients, shareholders and employees.

Clients – a well-diversified reinsurer will never imperil its ability to pay claims just because it sold capacity amounting to multiples of its capital base, or because it took on excessive exposure to one particular peril. Diversification enables a reinsurer to assume the volatility associated with its total portfolio of risks without the adequacy of its capital base being questioned. This, of course, requires that a fair price be collected for the covered exposure.

Shareholders – For the same reasons outlined in ‘Clients’ above, shareholders are able to obtain an appropriate return on equity relative to the intensity of risks assumed.

Employees – We believe nothing beats the pride of selling a good product. In the context of the reinsurance industry, this means maintaining the unwavering ability to pay legitimate reinsured claims at any foreseeable point in future. Delivering just that implies: 1) you’re actually listening to your clients and addressing their specific needs, 2) you develop and share technical expertise with colleagues working across various fields and 3) you use state-of-the-art tools and processes.

Strategic model, consistency and transparency can also be used to discriminate between reinsurers. We encourage our clients and their brokers to ask reinsurers questions inspired by these considerations. Let us all foster a long-term mindset of fair, technical pricing. It is well worth the conscious effort because, as long as the business is priced appropriately, a reinsurer will be able to provide sustainable coverage that is perfectly tailored to the insurer’s portfolio.

Andr Fredette Senior vice president of Caisse Centrale de Rassurance (CCR) Canada

While preparing for this year’s article on the reinsurance market, I reviewed what I had written last year at this time. The analogy of how the same vineyard can produce different grapes and wines from year to year came to mind.

Property Catastrophe – The effects of Katrina and Rita will cause some reinsurers to push all worldwide cat rates up. The U.S.A. will have the largest increase. Other countries, such as Canada, will contribute to a lesser degree to the rebuilding of capital. Local reinsurers will review their portfolios with the Alberta floods and the August 19 Ontario rainstorm in mind. Treaties with no losses would be anywhere from “Renew as is” to an increase of 10%. Treaties with partial or full losses to the layers would be anywhere from 20% to 40% more.

Property Per risk – A number of reinsurers in the U.S.A. are shocked that as much as 50% of their cat losses from Katrina are coming from property per risk treaties. Some now feel the catastrophe loading for per risk treaties has been underestimated. Rate increases for clean treaties in the order of 10% would not be out of order.

Liability – This market should continue to remain hard. Old years still continue to deteriorate, but at a lesser pace.

Auto Excess – Ditto for auto regarding excess liability. We have only seen government- mandated rate reductions, which erode the premium base without doing anything to reduce catastrophic losses that impact the excess layers. The interest for this class will remain limited.

New for 2006 – Cat losses in the U.S.A. have shown the limitations of rating and accumulation models. In a complex global economy, it is impossible to take into account all the variables in a catastrophic loss. The models are good for average losses, but when a loss is above average we see how things can converge. For example, once New Orleans was flooded, power, communications, water supplies and sanitation were also lost. This vastly complicated determining the final values of the insured loss. There will be a re-think of blindly following black boxes and I am sure much work will be done on improving capital protection for reinsurance companies.

Roy Vincent Senior vice president of Canadian treaties at Hannover Re

What a great year 2005 could have been – but then Katrina happened, the most expensive natural catastrophe in insurance history. Apart from the tragic loss of life, the traumatic pictures of a post-hurricane New Orleans remain. The reinsurance market is once again being tested. For the multi-disciplined reinsurers, at least, other profitable lines of business have offset losses. However, many of the mainly catastrophe reinsurance markets have been hit hard and are in need of additional capital. This will only be available at a price. To add to this, rating agencies have heralded changes to their models and that will put additional pressure on reinsurers’ capital. The retro market, if it still exists, will be demanding. What does this mean for Canada?

In the U.S., catastrophe models can rely on a number of events sets to assess exposure; nevertheless, it is noteworthy the estimates for recent hurricane losses showed large discrepancies. In Canada, we do not have even have the event sets, leaving the models open to even more interpretation. With the major models concentrating on earthquakes, there is a lot of guesswork on the other perils that are covered in Canada. The glib talk of a “one-in-100-year storm” is now a 20-year return period event. Reinsurers in Canada will need to use more underwriting ju
dgement and adjust pricing before the models have all the answers.

Proportional property has always been a difficult class for reinsurers. Over the long term, I doubt whether any reinsurer in Canada has made a profit, let alone met their needed margins. As proportional business is mainly commercial, the continuing rate decline is unwelcome. Without further stability on rates from our ceding companies, I can see reinsurers continuing to turn away from this line of business.

Property Per risk will continue to be rated according to results and exposure.

Automobile and general liability business continues to be problematic. It appears that automobile accidents – for a number of unclear reasons – have been going down, but severity continues to go up. This obviously is an area of concern for reinsurers. Further, most treaties do not simply cover automobile but general liability as well. While we can be fairly confident automobile losses will be known quickly, the same cannot be said for general liability. Assessing loss cost trends for automobile is difficult, but it’s even harder for general liability, where the losses are unknown. Reinsurers will have to take a hard look at both these elements and, where necessary, adjust terms and conditions.

Capacity (licensed) will be available at the right price.

Nicholas Smith Attorney in fact in Canada for Lloyd’s Underwriters

As we approach the traditional renewal season, it is clear the staggering cost to the insurance industry of Hurricane Katrina – estimated by some analysts as a hit of more than Cdn$70 billion, and already described by some industry leaders both inside and outside Lloyd’s as a market-changing event – will be the key factor in the minds of Lloyd’s underwriters and their capital providers as negotiations with Canadian cedants get underway. This presumes no further impacts from Wilma or any putative Greek-sounding windstorms.

Lloyd’s has put the market’s initial loss from Katrina at over Cdn$3 billion, second only to 9/11 as the biggest hit in its 300-year history. The financial impact is equivalent to the combined losses from the four U.S. and Caribbean hurricanes last year.

In Canada, Lloyd’s reinsurance book is primarily property and casualty, and Katrina has particularly affected this market segment. Sources to whom I have spoken indicate expectations are that rate increases on the order of 20-25% will be sought for Canadian business. Although these conditions may also act to increase capacity – a number of capital providers have announced that they have revised their original plans and will increase their capacity to take advantage of more favorable pricing – this is subject to the caveat that, in the new Franchise Performance environment at Lloyd’s, there is a conscious need to ensure that rates are commensurate with the nature of underlying risks. I do not believe Lloyd’s underwriters will be alone in seeking rating increases. As we have seen with Hurricane Andrew in 1992 and the terrorist attacks of 9/11, in an industry as globalised as reinsurance, severe loss experience in one part of the world will have an impact on markets elsewhere. One can also expect experience in Canada to have an effect; while the Suncor explosion and the August 19 Ontario storm have not affected Lloyd’s reinsurance market to any great extent, they are significant loss for some carriers here. All reinsurers should be mindful of the fact that although the last two years have seen underwriting profits for reinsurers, the experience before that was an unhappy one. All should also now be conscious of the power of events to shape market conditions. Prior to August 19, prior to Katrina, many talked of softening conditions in Canadian reinsurance markets. We are unlikely to hear that repeated this fall.

Peter N. Borst Vice president and chief agent of Canada, GE Insurance Solutions (Employers Reinsurance Corporation)

Reflecting on industry results of the past few years we can be pleased with our progress. The industry has underwritten to a profit as well as generally obtaining rates that are commensurate with the risk it assumes. There were some signs of rate softening, but now expectations are that even a slight softening trend will be quickly reversed as a result of the storm and large loss activity suffered in 2005.

Clearly, having caused US$35 billion to $60 billion in insured losses and rising, Hurricane Katrina is a major market event that will have implications for all property and casualty insurance markets. The hurricanes have put enormous ratings and capital pressures on insurance and reinsurance companies.

In Canada, this has been a challenging year for weather related events as well. We’ve had flooding in Calgary and Edmonton, the June Prairie storms and excessive rainfall in the Greater Toronto Area in August.

The point is that our world is changing. Weather activity is increasing as are insured values exposed to loss. Globally, during the past two years, we have seen six major losses among the top eight insured natural perils losses in history. As an industry, our technical underwriting must reflect these realities.

What does this mean for us as we head into the 2006 treaty renewal season? Historically, an increase in exposure has usually resulted in increased price; the greatest price increases have emerged in Property Catastrophe lines and few if any other lines are immune. Cost inflation should be covered during any point in the industry cycle.

Critics contend there should be plenty of capital to accommodate future events like Katrina and the Canadian storms. We admit surplus is at its highest level ever and represents a real sign of strength for our industry. However, surplus isn’t free. Our investors expect a return on capital, and they expect a return of capital in the future. It’s clear insurers and reinsurers are facing increased exposures.

At GE Insurance Solutions, we will continue to use our strong financial position and capacity to support our customers. Our emphasis will be on middle market business, where pricing and terms remain more consistent over time. We will share our world-class analytics with our customers to help them succeed. And we will maintain our underwriting discipline to help endure market cycles.

Ken Irvin President and CEO of Munich Reinsurance Company of Canada

The recent spate of weather-related catastrophes around the globe indicates the accumulation and concentration of insured values in heavily populated areas has increased exponentially during recent times. Despite the best intentions of modellers, this increased exposure has been woefully underestimated. Likewise, catastrophe program rates have not generally recognized these concentrations, nor priced for the type of catastrophe losses we now see.

We in Canada cannot look south of the border or across the ocean to Europe and claim this is their issue, not ours. This year, a rainstorm cut a relatively narrow swath through southwestern Ontario and the northern edge of Toronto on Oct. 19 and resulted in the second costliest natural disaster in Canadian history – with estimated insured losses currently in the $500-million range. This type of loss event is not even captured as a scenario in today’s catastrophe modeling programs for Canada.

If Toronto were to experience a repeat of 1954’s Hurricane Hazel, the 50-plus years of sustained development in the region since then would result in insured losses thought possible only by earthquake. That models would call the storm a 1-in-100-, 1-in-250- or a 1-in-500-year event is of cold comfort in the present.

In the upcoming treaty renewal season, we anticipate concentration of insured values to be a topic of concern for insurers and reinsurers alike, with the commensurate risk-adequate pricing negotiations for catastrophe covers. We have been tracking the softening in the property market at the primary level and would expect that trend to stop or reverse given recent events. There should be
sufficient capacity to meet the needs of insurers but that capacity will be at terms that recognize the growing costs of both individual and catastrophe losses.

Casualty rates are definitely holding and in many cases increasing – this is out of pure necessity.

In the formerly staid world of insurance, there is currently never a dull moment and the spotlight always seems to glare on our industry. MROC will work with insurers to provide the best possible business solutions for their reinsurance needs – through tumultuous times, we take the long view.

David Wilmot Senior vice president and chief agent in Canada for The Toa Reinsurance Company of America

How would Elvis handle the current renewal season? Despite all the forces of nature displayed in 2005, reinsurance buyers, brokers and sellers seem intent on entering the current renewal cycle with a “same-old” attitude that belies the degree to which Katrina et al. shook up the market. Looking at our industry through another’s eyes may provide the perspective needed to plan for the coming year.

Following the path of Elvis’s career, reinsurance has moved from innocent good faith to hard-headed finance. Elvis signed up with Colonel Parker on a handshake (something reinsurers once did), but in later years faced the cold cruel contracts of West Coast show-biz – a business not so much of music as of money. Would Elvis recognize that today’s new reinsurance investors are all about short-term capital and not the spread of risk?

Post-Katrina reinsurance capitalization suggests a tiring on the part of capital markets. So far, only $6 billion has been raised to refinance the $40-billion to $60-billion hit taken by the reinsurance community. Most of that $6 billion is speculative, in the form of equity, including – in at least one case – new shares to allow those who shorted reinsurance stock prior to Katrina to take their gains.

Elvis would understand today’s growing interest in reinsurance solvency. (He knew that many depended on his ability to perform.) But he might have trouble understanding the buyers’ preoccupation with price. The correct answer, of course, must be: “Which do you want, price or security?” The events of 2005 demonstrate that now, more than ever before, there must be something in it for professional reinsurers. If they can’t collect premium for value in Canada, then their currently limited capital will be put to use elsewhere. It’s now or never for correct pricing and terms.

This continuing transition to a more stable market will manifest itself in many ways. Canadian reinsurers will by and large continue to receive their marching orders from very sober parent offices. Capital allocation may even change the Canadian reinsurer’s appetite for quota share reinsurance. (Unlike Elvis, we may lose our craving for empty calories.)

Reinsurance is intended to provide stability of experience. To date, we have been the devil in disguise, offering instead an aggregating contribution to destructive market cycles. If we can’t get this straight at renewal, then we may all find ourselves singing Heartbreak Hotel.

Steve Smith CEO, Farm Mutual Reinsurance Plan (FMRP)

Canadian reinsurance results were very interesting in 2005. Some companies were faced with several catastrophe losses, while others went relatively unscathed.

The Canadian auto results reflected an overall improvement, primarily due to a reduction in frequency of Ontario accident benefits. And yet Bodily Injury claims are showing signs of potential for significant adverse development, bringing the current levels of IBNR under scrutiny. In the meantime, all jurisdictions governed by private auto carriers are under pressure to reduce primary rates.

Up until Hurricane Katrina, the 2006 renewal year was expected to be relatively uneventful, with renewals pretty much reflecting the ceding company’s own experience. Unfortunately Katrina changed all that.

Katrina will be the first significant loss for many of the Bermuda reinsurers, which emerged with new capital following 9/11. Unlike 2004 – in which the series of Category 4 hurricanes were buffered by four net retentions of primary insurers – reinsurers were faced with one loss, therefore one primary retention. The effect of this loss will no doubt be felt throughout Canada and the U.S.

Any downgradings that flow from the hurricane activity will result in treaty massaging in order to satisfy treaty mandates that require reinsurers to maintain certain minimum ratings. The London cat market will also see widespread losses that will certainly drive supply and demand. In addition, many Retro covers were burned through, resulting in capacity uncertainty for many reinsurers.

Companies that expected a modest decrease in reinsurance rates pre-Katrina, can now expect a marginal increase. Companies that had the misfortune to be affected by the Alberta floods and the August 19 Ontario storm will no doubt be faced with significant rate increases. Overall the Canadian insurance industry will likely see reinsurance rate increases in the 15% range as opposed to what would have, or should have, been a 5-10% decrease.

From the Canadian Farm Mutuals perspective, 2005 was a very interesting year to say the least. From a catastrophe loss point of view, the Western Mutuals experienced nine losses, primarily from windstorm. Ontario Mutuals felt the effect of the August 19 storm, although that effect was relatively minor compared to that felt by the industry as a whole. The Maritime Mutuals, on the other hand, enjoyed a generally favourable 2005. Generally speaking, the overall Auto and Casualty results, as well as the Excess Property per risk experience programmes for the Farm Mutuals, were very positive.

During 2006, the reinsurance climate for the Mutuals is expected to be relatively favourable. Our operational focus will be to work diligently with our 61 Mutuals to address both Insurance to Value and Loss Prevention. These initiatives will not only serve to improve both primary and reinsurance premiums generated, but also reduce the frequency of large losses that effect reinsurance loss activity.

Henry Klecan Jr. President of SCOR Canada Reinsurance Company

Will rates rise? Will there be sufficient capacity to handle our needs? Will there be market impact in Canada as a result of global catastrophic losses?

These are some of the issues with which re/insurance stakeholders – cedents, reinsurers, reinsurance intermediaries, reinsurance consultants – are wrestling as we prepare to embark on another renewal season.

Natural (i.e. weather-related) catastrophes, although unpredictable, have now become an annual event. Their unpredictability lies in identifying what part of the world will be affected. Weather patterns have brought about severe weather conditions in various parts of the world – torrential rainstorms and flooding in northern and central Europe; drought and subsequent fires in southern Europe; cyclones in Asia, hurricanes in the United States and not to forget earthquakes in other parts of the world. Loss severity events also affected the Canadian re/insurance market, starting in January with the Suncor loss. Several weather-related losses followed during the year, in addition to normal claim activity that did not necessarily warrant front-page headlines but were important nonetheless.

Our industry has been affected in varying degrees by these events. As actors on a global stage, reinsurers apply risk management techniques to mitigate the impact of any one large event or series of events. However, the cost of these world-wide events must be shared by all stakeholders in order to maintain a viable global market.

Post-Katrina, as a reference point in time, is a reality we cannot escape. Reinsurance capacity, per se, should not be a problem as the industry awaits further developments from the retrocessional market to determine cost and level of capacity; reinsurers’ risk selection appetite and pricing is expected
to be closely aligned with risk assessment guidelines including capital allocation and pricing models post Katrina. I expect to see an upward evolution in reinsurance pricing commensurate with loss experience, risk assumed and capacity required on a per cedent basis.

Here is a prospective view of challenges that remain in our industry:

– concerns about terrorism insurance and the ability of the private sector to respond remain unanswered;

– “fire following” issues remain unresolved;

– debate continues over the continued role of rating agencies versus the federal and provincial regulatory authorities in determining re/insurers’ financial strength; and

– homogeneity of regulatory oversight, etc.

The industry is certainly not “issue free” as we enter the 2006 renewal season.

What should you expect from SCOR? No surprises – we are open for business and will respond professionally to the needs of our clients.

Cam MacDonald Regional vice president for Transatlantic Reinsurance Company

Just when the year seemed to be progressing nicely, along came a catastrophic loss – then another, then another, then another. The unprecedented hurricane activity in the southern United States, coupled with multiple weather related losses here in Canada – including the largest loss ever in the province of Ontario – will undoubtedly have a profound impact on reinsurance terms throughout the upcoming treaty renewal season. Rates for top layer catastrophe covers will be increased, as well as costs for retrocessional covers. However, the magnitude and frequency of these large losses may have a more far- reaching global impact on both reinsurance and primary markets across all lines of business.

Operational losses suffered from events such as Hurricane Katrina are severe; in some instances, capital positions have been affected. The softening market conditions we’ve been experiencing have changed literally over-night as markets look to recoup their losses.

As the list of companies placed on credit watch continues to grow, financial ratings and security issues are again at the forefront of renewal discussions. One Bermuda-based reinsurer is now in runoff; there is concern in the marketplace that other companies may suffer the same fate. Rating agencies such as A.M. Best and Standard & Poor will have many changes to announce as the full impact of the recent and any future catastrophe losses (Wilma) become fully known. The flight to quality is now evident, as smart buyers look to secure “A” rated capacity from local markets with a long and successful track record. To do otherwise is a risk that could jeopardize a company’s very existence.


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