After the Losses

Given the catastrophic activity of 2011, both globally and locally, industry observers expected the reinsurance market to harden as of Jan. 1, 2012. The surprise lay in the extent of the hardening and the degree in which capacity was reduced. The chronology of 2011 loss events and the reality that most Canadian renewals take place at Jan. 1 conspired against brokers and buyers. Rates and exposures were up and the implications for primary rates, particularly in personal lines, should be quite clear. Whether this upward pressure will be similarly exerted on commercial insurance rates is not as readily perceived, but it’s certainly worth looking at some of the indicators.

2011 Losses

Let’s quickly review the 2011 losses. The current total for significant catastrophe losses (each over $1 billion) in 2011 is hovering around $105 billion. This comes very close to eclipsing the historical record set in 2005, the year of Hurricanes Katrina, Rita and Wilma (KRW). Whereas the KRW losses were largely personal lines events arising from a single peril in one region, the 2011 activity was far more varied with respect to regions, perils and classes of business. The severity of the 2011 losses also stands in contrast to the relatively meek 2010 experience.

Specifically, the earthquake in Christchurch, New Zealand on Feb. 23, 2011 is the third costliest earthquake in history. Its source was a previously unidentified fault. The significance of this loss for reinsurers was the severity relative to the regional premium base.

Less than three weeks later, the Tohoku earthquake in Japan, an undersea mega-thrust quake measured at a magnitude of 9.0 Mw, knocked out three nuclear reactors and shut down six Sony factories that manufactured such diverse items as camera lenses, integrated circuit cards and a substantial share of the world’s lithium-ion batteries. Toyota, Honda and Nissan were all shuttered for extended periods as a result of the quake. So were auto plants in the United States, Canada, Germany, Sweden, Mexico and Brazil due to a lack of Japanese-made components. This was the year’s first reminder of the daunting exposures inherent in contingent business interruption (CBI) policies. It would not be the last.

As the year unfolded, there were floods in Australia, tornadoes across the United States, Hurricane Irene and, with disastrous timing, the flooding of two-thirds of Thailand.

The floods in Thailand hit the manufacturing facilities of global corporations such as Honda, Toshiba, Sony (its second-largest plant outside of Japan), Canon and Fujitsu. In fact, the country’s 2011 Q4 gross domestic product dropped 4.6% as a result of the production shutdowns at countless facilities. CBI coverage once again took an unprecedented hit. Again, the loss was primarily commercial in nature. In addition, as in the New Zealand quake scenario, the event happened in a non-peak zone where decades of reinsurance premiums were insufficient to cover the loss. Lastly, the flooding began in October, just as reinsurance renewal negotiations were in full swing.

Coinciding with a heavy global cat year, the Canadian experience included the devastating fire at Slave Lake ($750 million), Alberta wind and hail in July ($200 million), a tornado in Goderich, Ontario ($100 million) and lastly, after most reinsurance renewal quotes had already been formulated, the freak Calgary wind loss of Nov. 27 ($200 million). Despite its lower quantum, this last item seemed to shake the market more than the Slave Lake event. This is partly because it happened so late in the year. Also, it caused damage that hadn’t really been seen before — like glass blowing out of downtown office towers — or that, according to building codes, wasn’t ever supposed to happen.

With all of the foregoing in mind, noteworthy characteristics of the major catastrophic events of 2011 are as follows:

• Earthquake (with tsunami) frequency and severity was sufficient to remind reinsurers that Canada is subject to major quakes on the West Coast, in Quebec and in zones where faults have not yet been identified.

• Canada is a non-peak zone. As such, it delivers insufficient premium to cover potentially severe catastrophe losses.

• CBI coverage has not been sufficiently modeled or adequately priced.

• Events occurring late in the year, particularly the Thailand floods globally and the Calgary windstorm locally, set the treaty quote process back by at least two weeks.

• Canadian mini-cat ($10 million plus) frequency was higher than it has ever been, with harsh implications for cat aggregate contracts.

January 2012 Renewals

With all of these factors playing significant roles, Canadian treaty negotiations were slow, laborious and stressful. Now that the dust has settled, we have had an opportunity to look at some of the numbers.

Guy Carpenter’s share of the Canadian treaty market is about 40%, and our client base is diverse. Many clients incurred substantial losses as a result of the Slave Lake wildfires, the Alberta windstorm and the Goderich tornado. Others had minor cat occurrences below their reinsurance retention. Our client list includes national writers who are heavily oriented toward personal lines. We also serve provincial Crown corporations and regional clients who write in one or two provinces. We

have clients who focus almost exclusively on commercial lines. Our portfolio, therefore, is not in any way homogenous. Looking for trends, means and averages amidst such diversity is no simple task.

Given these caveats, I can report that our average client probable maximum loss exposure grew by 17%. Average catastrophe limits increased from $660 million to just over $800 million. Top layer rates on line moved up 12%, whereas program rates on line were 6% higher than a year earlier. Catastrophe aggregate excess of loss, risk and attachment adjusted, were up more than 50%. Overall, our catastrophe clients spent 28% more, keeping in mind that they also purchased more reinsurance.

These purchases were not easily negotiated. Many programs came in well below prior year authorization levels; most came down to the wire on Dec. 30 for completion.

The emergence of non-concurrent terms provides another indicator of the hardened market. Some brokers increased the rate to attract the last 20% or 30% of a placement. We do not view this practice as providing a cost benefit to our clients (over an accurately targeted rate at the outset). The renewal hurdles for 2013 will likely trigger painful price adjustments as reinsurers seek ultimate rate equality.

Where does all this lead? We think insurers in the personal arena are already primed to transfer the increased cost of reinsurance to the consumer. Those costs are not insignificant; in our modeled estimates, they will account for as much as 20% of homeowner policy premiums.

Commercial insurance is a different animal. Cat losses in Canada have not been meaningful for many commercial writers. Numerous players access their capacity through global covers that may not have been hit with large rate increases, or that can be lost sometimes in a regional allocation. The handful of heavy commercial writers in this country has generally reported strong results.

But the writing is on the wall and the experience in places like Japan and Thailand will have ramifications. Capacity for industrial companies will have to come at a higher price. Manufacturing facilities should feel the ripples of the global CBI experience. Certainly, the dominant indicators suggest that the commercial insurance market has hit bottom and upcoming renewals will see moderate upward rate movement.