Reinsurance Broker Perspective: Drivers of 2003 Renewals

The 2002 treaty negotiations were dominated by terrorism clauses and large price increases. Other issues which would normally have been raised were either pushed aside or, like “cyber risk”, handled with almost no difficulty. Many reinsurers set time limits on their quotes and authorisations and, because of this, little thought was given to alternatives to existing programs.

The 1st January 2003 renewals will be different. Established reinsurers have counted the cost in lost capital from the soft market, the attack on the World Trade Center (WTC), the equity markets and losses on bonds issued by companies like Enron, WorldCom and the like. The new reinsurers have had time to establish themselves and make plans, rather than just respond to opportunities on a day-to-day basis. Ceding companies have measured the increase in the cost of reinsurance, seen the impact of changes in their primary market and had time to consider what changes they want this time.

There is no doubt the price of reinsurance will increase again, but capacity for most classes and most ceding companies is not an issue, so it is not a typical hard market. There is more time this year for real negotiations, so what could not be dealt with last year will be discussed this year. Both ceding companies and reinsurers have their agendas, with few items in common.

Terrorism

The terrorist threat is still very much on the minds of reinsurance buyers and sellers. However, most ceding companies are providing their insureds with less cover than their reinsurance would permit, so it will be a background issue for most this year. There is some cleaning up to do in some clauses used for 2002, but this should not be contentious. The only likely change is a further reduction in “out of Canada cover” to statutory cover only. However, for those companies specializing in high value and potential target risks, cover will remain a problem.

Asbestos

Asbestos has not been seen as a Canadian problem for the insurance industry, however, the expansion of asbestos lawsuits in the U.S. is causing local concern for reinsurers. As a result, asbestos exclusions will likely be looked for on any U.S. exposures and for any Canadian products likely to find their way south of the border.

Nuclear exclusion – fire following

Provincial laws, other than in Quebec, make it difficult, if not impossible, to exclude any cause of fire from a policy primarily covering fire losses, unless the cause falls under the war exclusion. Reinsurers have generally recognized this in their terrorism clauses by providing such coverage to the extent required by law. However they have developed a concern about the possibility of fire following a nuclear incident, terrorist or otherwise, and are proposing that it be excluded from reinsurance contracts some time during 2003, even if it cannot be excluded from insurance contracts.

The Insurance Bureau of Canada (IBC) has been trying for many years to have this provision of the provincial laws changed so that fire following earthquake need not be covered if shock is not covered. The bureau increased its efforts after the attack on the WTC, but still without success, indeed without much indication of real interest on the part of the provincial governments to consider it.

This attempt by reinsurers to avoid providing reinsurance of a coverage which their clients are obliged to give, which, if successful, could be followed by a similar move on fire following terrorism, seems to have two possible motives. First, they wish to avoid giving coverage they believe could damage their finances, particularly when it is given almost nowhere else in the world. Second, their move will certainly spur clients to redouble their efforts to get a change in provincial laws, and, by raising the prospect of wholesale bankruptcies amongst insurance companies, put real pressure on reluctant provincial governments.

The danger for reinsurers, however, is that they will indeed accomplish legislative change, but rather than the removal of the need to provide fire following, legislators may find it just as easy, and politically more acceptable, to change the legislation so that the current rule applies equally to reinsurance contracts.

Mold

Mold should have been dealt with this year as easily as cyber risk was last year, since it is not, in itself, a contentious issue. However, the IBC has produced an exclusion which reinsurers, as well as the bureau’s insurer members will not accept. Clearly the industry mechanisms have broken down somewhere. As a result, reinsurance mold exclusions will need to be negotiated case by case and a great deal of time will be spent on something which should have already been resolved.

Outside Canada

Most reinsurance contracts are limited to Canadian exposures and incidental exposures elsewhere. This is designed to pick up sales offices, distribution centers and the like owned by Canadian insureds, usually in the U.S. However, with the increased “globalization” of Canadian business, the interpretation of “incidental”, which was never clearly defined, has become a potentially contentious issue.

Reinsurers will be looking for a clear understanding of its meaning. So long as this understanding is reached after discussion with the ceding company and reflects the nature of the ceding company’s portfolio, rather than being “one size fits all”, this should not cause problems.

Insurers’ agenda

As would be expected in this type of market, most of the issues are being driven by reinsurers. Ceding companies are generally looking for no more than stable rates and conditions after the pounding they took at last renewal.

Reinsurer security is always a concern in the back of the minds of insurers. But, with recent market difficulties, such as with Gerling Re, this attention has become far more focused. This factor will likely play heavily in the upcoming treaty renewals.

Normally rapid price increases bring about increased retentions, but that does not seem to be a common theme this year, unless further price increases are found unreasonable. The changeover to the minimum capital test (MCT), continuing problems with automobile insurance – and not just in Ontario – and the difficult investment climate seem to present companies with enough additional risk for next year that they are content to keep retentions where they are.

As reinsurers introduce an increasing number of cover limitations, ceding companies seek assurance that they are on a level playing-field. To Canadian companies, this means that the limitations are applied equally to all companies in the market. For larger international companies, it can also mean that the same rules are applied by all offices of the reinsurer around the world. This latter requirement is difficult for reinsurers to achieve, since legislation and market conditions and practices differ substantially from one country to another. Within Canada, it goes against an increasing desire on the part of reinsurers, generally supported by ceding companies, to underwrite the company rather than apply market rules. For example, contingent business interruption is a concern for many reinsurers. Ceding companies may understand if they apply stricter rules to a company with a portfolio of risks which pose particular problems for that cover, than to a company with a less exposed portfolio. However, if reinsurers give better terms to one ceding company over another with a similar portfolio, based on their evaluation of the expertise of the underwriters, one of the two companies will be less than understanding. Nonetheless, they hopefully will have the courage to do it so that the better companies are appropriately rewarded.

The major issue for ceding companies is undoubtedly the cost of reinsurance. As they see their own books of business producing improving results, they will not want to pass on to reinsurers more than they perceive as reinsurers’ “fair share”, so negotiations over price will dominate this year’s renewals.

Sellers’ market

This will be another sellers’ market, as was the case with last year.
This, however, is where the similarity ends. There will be more time for negotiation and more time to examine alternatives, so all parties will be challenged. And it will be a challenge not faced during several years of a buyers’ market. In essence, the upcoming treaty renewals will be a year for professionals to prevail.