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Altered State


November 1, 2016   by Canadian Underwriter


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Fort McMurray. It is a rare thing that two short words manages to capture all measure of both current and future loss, damage, effort and emotional toll.

But happen Fort McMurray did. Estimated to become the largest natural catastrophe insured loss (by far) in Canadian history – the majority of which is expected to be borne by reinsurers – the hope is the devastation wrought by the raging, expansive wildfire will have a more hopeful and helpful result.

Surprised or not by the influence of an occurrence in such a remote area, Fort McMurray guarantees the last few years of billion-dollar insured losses from natural catastrophes in Canada continues. It is not a game-changing event for the reinsurance industry, but many reinsurers argue rates clearly need to reflect reality, and that means increases.

Perhaps more important now, though, is that the Canadian experience in 2016 may provide a stopper on the recent history of reinsurance buyers almost expecting that rates will decrease yet again.

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This year may also prove key from a reinsurance perspective as it contributes to putting Canada in a different light. Should Canada still be regarded as a diversifier? Will recent events invite more capacity or less?

One thing, however, does seem clear. There is a need for rates to truly reflect risk.

Is there a need to rethink forest fire risk in Canada? Will regional companies retreat from certain provinces? Will predictive science help shed light on perils? Does the re/insurance industry need to revisit its aggregation and pricing methodologies? Will Canada’s run of insured losses represent a game-changer for insurance-linked securities activity in the country? What role will climate adaptation and execution of technology-enriched offerings play in the coming year? Is the stage set for firming of catastrophe pricing? Will the upcoming renewal season be business as usual? Is Canada no longer considered benign with respect to large nat-cats?

What do all these questions mean for how reinsurers here at home and around the world view Canada? Canadian Underwriter asked senior executives of reinsurance companies in Canada what they expect to unfold in 2017.

1 Donald P. Callahan
President & Chief Executive Officer
Guy Carpenter Canada

The story of the year is Fort McMurray. It is a poignant story for the families involved and they should be the first concern both as Canadians and as professionals in the re/insurance industry.

At the same time, the industry should be proud of the role it plays in returning these families to a semblance of normalcy. Upwards of $3.5 billion will be injected into Fort McMurray and reinsurers will likely shoulder 75% of the loss.

This is significant when one considers the Alberta government’s most recent economic statement, which suggests that the province’s gross domestic product growth in 2017 will be a healthy 2.4%, largely fuelled by the reconstruction in Fort McMurray.

Despite that significance, Fort McMurray is not a game-changer in reinsurance. Reinsurers may argue the loss arose from an unmodelled peril and that this single loss has extinguished years of premium and, consequently and accordingly, Canadian reinsurance rates will materially increase.

The reality is that the Fort McMurray loss represents less than half a per cent of global reinsurance capital – nowhere near enough to move the global needle. The wildfire peril was, indeed, modelled, or it should have been, after Slave Lake in 2011 and Kelowna in 2003.

Furthermore, the Fort McMurray event is not easily replicated elsewhere or in the future because of the financial distortions that were created by the energy sector.

Prior to the fire, the municipality boasted the highest housing prices in Alberta, higher than Calgary or Edmonton, at more than $500,000 for the average detached home.

By a multiple of five, its 80,000 people made Fort McMurray the largest city in the wildfire-exposed North. Incredibly, this sizable population is more than 400 kilometres from an urban centre and firefighting infrastructure. This was both a perfect storm and a black swan.

The meaningful lesson is a renewed focus on catastrophe limits purchased, hours clauses, property per risk occurrence limits and, presumably, the value of reinsurance.

 

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

With the holiday season coming up, it is worthwhile remembering that the reinsurance industry does not like surprises.

Although not on the same scale as the Thai flood or the Christchurch earthquakes, the Fort McMurray wildfire was a rude wake-up call to reinsurers. Not only is Fort McMurray the largest Canadian loss ever, it is also the largest forest fire loss worldwide.

It is fair to say most reinsurers have gone back to their pricing model, and are refining their view of forest fire risk.

Is this an Alberta problem? Of course not.

California routinely has costly forest fires, and the Kelowna, British Columbia fire happened only 13 years ago.

But it is not a west coast problem, either. What happened in Alberta and British Columbia could also happen in Ontario or Quebec. For example, in May of 2012, the northern Ontario city of Timmins was under a state of emergency as a forest fire raged a few kilometres west of the community.

Of course, the real estate in Fort McMurray is more expensive than in Timmins. Also, Fort McMurray is more isolated, so the cost of reconstruction will be higher.

Had the fire in 2012 burnt part of Timmins, the loss to the industry may not have been as high as Fort McMurray. Still, expect the view of risk to change for all of Canada, and not just out West.

More worrisome is the continuing trend of severe storms and hail events in the Prairies, and in Alberta, in particular. It raises questions around the sustainability of the regional insurance company model, and around the affordability of the homeowner product in Alberta.

Unfortunately, there are no easy answers to such questions.

But the reinsurance industry will work with all concerned to come up with the appropriate solutions.

 

3 Patrick Li
Senior Vice President & Head of Canada
PartnerRe

The raft of natural catastrophes to have hit Canada in the past few years is well-documented, culminating in the Fort McMurray wildfire earlier this year, which forced more than 80,000 people from their homes and caused incalculable losses to the community.

Insured losses from the massive fire were $3.58 billion, notes figures reported by Insurance Bureau of Canada, more than twice that of the 2013 southern Alberta flood, which cost $1.7 billion in insurance claims.

The wildfire and the damage it caused were one element in the extreme weather events that have increased in both frequency and severity in Canada in the past decade, and the re/insurance industry has been working with the people, businesses and government to help the country through these disasters.

Smaller, regional players are especially impacted by unmodelled perils such as these. Buying the right level of catastrophe coverage proves challenging when Cat purchase is based on, for example, modelled earthquake risk rather than the reality of their exposures.

In some cases, these regional companies have even been forced to pull out of certain provinces as a result of the impact on their bottom lines. These companies, in particular, stand to benefit from reinsurance partners who can offer non-traditional, customized solutions and best practices gathered internationally.

The global soft market in reinsurance has seen falling prices for many years, and in Canada, levels are reaching what is now considered to be unsustainable.

While the Canadian reinsurance market is stable and mature, over-capacity has been pushing prices down.

But the claims paid in the past decade mean pricing is now being seen as inadequate, and the feeling in the market is that reinsurers have reached an inflection point.

Something has got to give.

It is in everyone’s interest that risks are priced to reflect the perils they insure and the market is sustainable and vibrant long-term.

 

4 Geoffrey Lubert
Executive Vice President & Managing Director
Willis Re Canada

Alberta. What to do with Alberta?

This beautiful province has been the source of some of the largest insured losses in Canadian history: flooding, hailstorms and wildfire. Luckily, Alberta is at low risk for an earthquake.

As a result, insurers, reinsurers, catastrophe modelling companies and reinsurance intermediaries are rushing to attach more predictive science to these perils as a way to better assess exposure and prevent financial instability in the future. Although these are reactive responses, they are positive, nonetheless, for all concerned.

In the absence of local or global catastrophe losses resulting in capital events for reinsurers, most Canadian buyers of reinsurance will continue to enjoy favourable conditions for 2017 (assuming a quiet 2016 Q4).

Despite the low rates and thin margins, Canada remains an attractive destination for reinsurance capital and capacity. Reinsurers understand that Canadian reinsureds, for the most part, take a long-term view of their annual purchases. Moreover, Canadian buyers and their intermediaries deploy sophisticated analytics that enable reinsurers to understand and rate the exposures.

The use of analytics, including catastrophe and financial modelling, is embedded in virtually every reinsurance transaction today. Notwithstanding this technical wizardry, many insurers still struggle to plot their reinsurance retentions, limits and levels of co-reinsurance that precisely reflect their risk tolerance. Intuition will always play a key role in these metrics.

To create further scale in a competitive global marketplace, insurers and reinsurers continue the trend of mergers and acquisitions (M&A).

The Lloyd’s market remains a popular source of acquired companies; in addition, the merger between Towers Watson and Willis was successfully completed earlier this year. M&A will, no doubt, continue globally at every level in this industry as companies look for economies and market share.

Soft markets can be challenging for underwriters and brokers alike. But, for fully invested intermediaries with strong broking teams, the prevailing conditions can create significant opportunities. The insurance market and the resultant reinsurance programs are, in fact, expanding, not constricting.

Innovation and cutting-edge technology win out over pessimism and complacency.

 

5 Cam MacDonald
Senior Vice President & Chief Agent – Canada
Transatlantic Reinsurance Company

The recent trend of non-modelled property catastrophe losses from both a frequency and severity perspective has given pause for thought on how the re/insurance industry quantifies and identifies risk.

It should be apparent to all that the re/insurance industry has severe and frequent exposure across the country from a variety of perils. Consider that the Calgary flood loss consumed approximately 100% of all annual reinsurance premiums (2013) collected in Canada, while the recent Fort McMurray wildfire loss will, ultimately, consume twice that amount.

Industry efforts to model these and other exposures are under way. However, it will take years before aggregation and pricing methodologies can be validated for all perils.

Nevertheless, it appears loss frequency and severity are, indeed, on the rise in Canada and if this is, in fact, the new normal, the re/insurance industry must revisit its aggregation and pricing methodologies from both a primary and reinsurance perspective.

A good place to start would be the large loss or catastrophe load factor as it appears underwriters are charging for only attritional loss activity.

The prevailing view of Canada being a non-catastrophic-prone zone has changed with the recent series of billion-dollar losses, especially relative to the annual reinsurance premium collected. The re/insurance industry simply cannot afford billion-dollar losses on such a frequent basis.

With regard to the upcoming treaty renewal season, it is anticipated those property accounts/layers impacted by both severity and frequency will experience some measure of rate adjustment.

While market forces will dictate the degree of rate change, the hope is that, as an industry, the importance of returning to technically adequate pricing is appreciated.

 

6 Frank Rückert
Senior Vice President, Canadian Treaty Department
Hannover Re

The Fort McMurray wildfire loss represents, by far, the largest natural catastrophe insured loss in Canadian history.

Despite the impact, however, it is not large enough to prove a market-changing event.

The global impact of 2011’s Cat events in New Zealand, Japan and Thailand had more influence on the Canadian market than even the floods in southern Alberta and in the Toronto area in 2013. Traditional reinsurers priced increases after 2013, but not to the extent they probably should have, had they considered sheer numbers on their own.

Although not market-changing, some changes should be expected in the coming year following Fort McMurray that will have more of an impact than 2013. There will likely be a change in terms of how certain exposures are viewed, and perhaps a rate increase for those exposures across all cedants, with loss-affected accounts seeing rate increases of between 10% and 40%.

More generally, it is expected that Fort McMurray will help put the brakes on regular downturn of rates, which over the last few years have been the result not so much of exposure as of market pressure and competition. With the amount of losses, including the severity of same, there should be consideration that there is no reason to have further rate declines.

There may also be a change with regard to insurance-linked securities (ILS) activity in Canada. With several consecutive years of large insured losses, the assumption is this could be a bit of a game-changer for the ILS markets.

Traditional reinsurers should see this as an opportunity, not a threat.

Events like Fort McMurray offer reinsurers an opportunity to demonstrate that they are long term-oriented and committed to the Canadian market, rather than chasing potential returns on an annual basis.

Some perils in certain parts of the country are still under-rated. With too much pressure and too much capacity, lower prices have been accepted, but the frequency and severity of the losses over the last couple of years have shown the right level has to be increased for certain perils.

 

7 Veronica Scotti
President & Chief Executive Officer
Swiss Re Canada

Climate adaptation and execution of technology-enriched offerings are expected to dominate in 2017 and beyond.

Resiliency and climate adaptation remain critical for society; it would be irresponsible to think otherwise. Often the immediate cost of making necessary changes eclipses the long-term benefits of those changes and turns a very avoidable future into an inescapable destiny.

In Fort McMurray, for example, waterways residents are being allowed to rebuild in a flood plain to inadequate risk prevention standards. It is an emotional and financial decision for residents who do not wish to relocate and cannot afford the expense of building to a more robust code.

As no one is willing to pay the additional cost – government, the insurance industry or individuals – the community is set up to repeat the mistakes of the past.

In 2017, the industry will continue to tackle the complexity and the opportunities embedded in technology and a steady emergence of technology in areas never before imagined is anticipated, perhaps from unsuspected players.

Already, the industry is seeing drones delivering great efficiencies to claims adjustment and, at the front of the value chain, insurance buyers clearly state they want convenience, simplicity and greater flexibility. It is likely the industry will respond with an increased level of sophistication in digitized sales platforms and underwriting operations.

Not only will transacting be made easier, but expanded coverages, novel services and helpful insights will be made available to consumers as insurers harness and analyze data from home telematics devices and connected platforms.

 

8 Steve Smith
President & Chief Executive Officer
Farm Mutual Reinsurance Plan

The Canadian reinsurance outlook for 2017 would appear to be facing a shift for the first time in several years.

While there continues to be overcapitalization within the global marketplace, catastrophic events, beginning with the Fort McMurray wildfires followed by an earthquake in Japan and two category 4 Atlantic hurricanes in October, will likely be setting the stage for the firming of catastrophe pricing, particularly for those insurers that have experienced a loss.

A focus for reinsurers as they head into the close of 2016 is the urgent need to develop a model for wildfire exposure, understanding concentrations and truly recognizing the significant risk that was so evident following Fort McMurray.

During the last year, many insurers

introduced products to respond to overland flood, with very little credible claims data or underwriting experience to support confident pricing at both the primary and reinsurance level.

During 2016, several storms occurred

across Canada, including the Prairies, southwestern Ontario and the Maritimes, bringing torrential rains and resulting floods. Most losses will be covered under the sewer back-up coverage provided by homeowner policies, reinforcing the need to model flood exposures by hazard zones and charging adequate premium at both the insurer and the reinsurer level.

Risk management and developing more sophisticated models for both wildfires and flood will be getting the lion’s share of reinsurers’ attention in 2017.

Reinsurers are continuing to experience a low-growth environment, relatively low investment returns and insurers increasing net retentions. Returns for investors and corporate parents will continue to be disappointing, maintaining pressure on underwriting returns, premium adequacy and identifying concentration exposures.

Reinsurers will also be committing resources to provide new opportunities and products, supporting organic growth and expansion opportunities as both top- and bottom-line performance continues to be under pressure.

 

9 Jonathan Stephenson
Executive Vice President
Aon Benfield Canada

It would be an oversimplification to try to distill down the impacts of the past year, coupled with the insurers’ and reinsurers’ challenging market conditions, to provide the sort of outlook that predicts reinsurance pricing will go up or down by some rationalized percentage. That would be the role of a reinsurance soothsayer.

Reinsurance agreements are individually negotiated between the primary underwriter and multiple reinsurance underwriters, with the important common denominator being that all the parties to contract are professional, experienced risk underwriters; albeit each with potentially very different perspectives.

The market conditions that the parties operate within are typically similar, but never identical, and the industry strives to reconcile these different points of view to arrive at the appropriate accord between insurer and reinsurer.

Very rarely does one encounter a market force that impacts all the participants in the same fashion.

Generally speaking, the market conditions in Canada remain competitive. Reinsurance capacity remains plentiful (locally and abroad) and the financial underpinnings of both cedants and reinsurers have never been more robust or more diversified.

Yes, there is an obvious point of friction for the upcoming reinsurance renewal season in Canada; the impact of the Fort McMurray conflagration loss on any given client’s property insurance portfolio.

But is this point of friction likely to have some sweeping impact on the upcoming reinsurance renewal season? Certainly not. Large catastrophe losses arise, and that is the very reason the affected reinsurance contracts were established – to share such losses.

So, given the absence of a market force that might drive sweeping change, the upcoming renewal season will be business as usual.

Portfolios will be analyzed, exposures evaluated, losses considered. Contract terms will be negotiated and contract pricing will reflect the merits of individually advocated positions.

Some contracts may cost a little more, some a little less, and some contracts will cost about the same. It will be business as usual, more or less, because that is the business.

 

10 Phillipp Wassenberg
President & Chief Executive Officer
Munich Reinsurance Company of Canada

The northern Alberta wildfires mark 2016 as being remarkable in many ways: the loss of over 2,400 homes in Fort McMurray, the evacuation of 90,000 people, many of whom could not yet return to their homes, many traumatized, fortunately no loss of life.

This has been Canada’s largest natural catastrophe in a long while, certainly since the ice storm of 1998 and, with more than $3.5 billion in insured claims, it has, by far, been the largest non-life loss in the country’s history.

Astonishingly, this has even been the largest insured loss globally in the first half of the year, before being topped by Hurricane Matthew.

In all, 70% or more of the Fort McMurray loss will be borne by the reinsurance community, which continues to prove efficient capital relief for the insurance industry protecting against catastrophe events.

Weather-related losses in Canada are unmodelled and ever-increasing with the effects of climate change. Wildfires in boreal forests, for example, directly correlate with too little snow pack, hence too dry, too early.

For years, the belief in the international reinsurance market was that it had found an ideal playing field in Canada for investing its abundant capital. True, there are two tremendous earthquake zones in British Columbia and Quebec, but uncorrelated with the east coast perils in the United States, thereby allowing for otherwise profitable years.

Really? Over the past few years, this expectation could not have been more thwarted. Canada can no longer be considered benign when it comes to large natural catastrophes.

It is time to factor all natural perils into the Cat pricing parameters. It is time to reflect on which reinsurers hold their Canadian risks net, not relying on a volatile retrocession market with all its uncertainty regarding continuity and future availability.

What happens if, eventually, “the big one” happens? It is time to rethink partnership with reinsurance.