November 1, 2003 by Vikki Spencer
For an industry that was on the brink of disaster less than a year ago, reinsurers can take pride in the financial turnaround seen thus far for 2003. But, CEOs offering their insights to CU’s annual yearend treaty outlook are not quiet prepared to pat themselves on the back for this year’s market performance. The sins of the past – soft pricing, loose terms and multi-year contracts – continue to put downward pressure on the industry. The message is clear: pricing discipline needs to be continued if the industry is to fully recover.
The vital statistics of the Canadian property & casualty reinsurance sector for last year tell the complete story – the 22 members of the Reinsurance Research Council (RRC) reported a combined ratio of 110.2%, and an underwriting loss of more than $225 million overall. The patient may not have been “DOA”, but certainly the sector was in the intensive care unit.
The cure, for reinsurers and their clients, was a bitter but necessary pill to swallow. Rate increases, tightened terms, the end of multi-year contracts, and new exclusions. Nonetheless, there were casualties – the demise of Gerling Global Re and Alea being the most prominent. For 2003, a recovery was not just hoped for, it was essential. And the tide is turning, reinsurance CEOs report.
Certainly, hopeful signs of easing capacity have crept into marketplace, specifically with several Bermuda-based players having indicated an interest to test Canadian waters. But, an ominous cloud still hangs over the reinsurance sector on a global level. Rating agencies have been unrelenting in their willingness to downgrade even the largest companies, and everyone from Standard & Poor’s to A.M. Best has placed a negative outlook on the industry as a whole. Rating affirmations, let alone upgrades, will continue to be hard to come by, the raters warn.
In Canada, reinsurers and their primary company clients, have faced new challenges with the most obvious being the unexpected jump in catastrophe costs – the B.C. forest fire and Hurricane Juan cast a pall on industry results for the second half of the year. And, auto insurance continues to be a thorn in the side of every insurer still willing to write the business. What does the current renewal season have in store? Reinsurers say the industry must continue to “take its medicine”. Price discipline and strict underwriting must be sustained if the industry is to regain its health and prosper, they warn.
Andr Fredette, senior vice president of CCR Canada
I have just dusted off my crystal ball and it tells me this season should be more predictable and even than the prior two [years]. There are, however, different forces at work and not all classes of business will be treated the same.
Property cat: The London and Bermudian markets seem eager to write more Canadian business and this may exert some downward pressure on rates. The frequency of small to medium losses we suffered this year (forest fires, floods, hurricanes, and blackouts) should temper the impulse to reduce rates.
Property per risk: This is very company specific and will be based on previous experience and the perception of potential future losses.
Property proportional: Capacity is available but not at the high commissions of a few years ago.
Auto excess: Layers below $3 million are seen as working layers and should expect increases of 25%-50%. This is because of the deterioration in reserves over the last few years. Also, the typical two-year lag before companies recognize the true extent of their losses has given reinsurers the impression that they are only seeing the tip of the iceberg in the renewal submission. Consequently, they are pricing the product on exposure rather than experience. Some reinsurance brokers are worried there is shrinking auto capacity. There is a lot of capacity but not at the old price.
Auto quota share: You’re kidding! Right! Who would want to write auto quota share when governments are freezing rates and preparing to further roll them back?
Liability excess: We are seeing more “American style” claims and lawsuits. Capacity is available but not at the old price. Also, reinsurers are less likely to give “free and unlimited” reinstatements on low layers. They will want some kind of cap on their exposure.
The most recent issue of the IAO quarterly shows that Canadian reinsurers on a rolling year average are still projecting a combined ratio of 108.8% with auto and liability being “profit challenged”. It is obviously too early to break out the “party hats”. The reinsurance industry still has a lot of work to prove to shareholders and rating agencies that it can make a reasonable return on capital. We should see a continuing hard but predictable market for the next two years.
Peter Borst, chief agent for Canada at GE Employer’s Reinsurance Corp.
Reflecting on 2003, one may be inclined to feel a sense of accomplishment in this business. Generally speaking, the reinsurance industry has made significant progress in returning to the foundations of underwriting discipline and sound, technical pricing strategy. All of this has been absolutely necessary when considered in light of reinsurer and insurer financial results over the past few years.
On the other hand, 2003 saw significant activity that adversely affects our business. We have seen rating agencies downgrade reinsurers and comment on the challenges facing our business. We have also seen more reinsurers withdraw this year, and I anticipate more withdrawals and insolvencies. Furthermore, the sector has experienced a flurry of weather activity including summer storms such as the Kelowna fires, Hurricane Juan in Halifax, and the Squamish floods as well as a near miss with Hurricane Isabel, which could have been much more devastating in terms of physical damage and insured loss to the global market.
As an industry, it is imperative that we continue to maintain the discipline in pricing and underwriting that we have only recently achieved. Only by doing so can the industry continue to provide the financial security that is the foundation of our business. At GE ERC, we will maintain our focus on appropriate technical terms and conditions and make data-driven decisions. We will also continue to focus on a select group of customers with whom we can develop and expand strong and deep relationships.
For Canada specifically, GE ERC will continue to emphasize property lines to balance our heavy weighting of casualty and automobile business. We will maintain our support of existing specialty coverages such as surety and professional liability. Our balance-sheet is stronger than ever given our reserve strengthening over the past three years, with a surplus in Canada of over $300 million and a solid, conservative asset base of over $800 million.
Matt Spensieri, vice president of General Reinsurance Corp.
It is that time of year again, for those willing, to offer predictions and share expectations for the upcoming treaty renewal season. For me, the most serious issue is the uncertainty that continues to prevail as to the survivability of individual companies, be they insurer or reinsurer. It seems almost daily that we read about various agencies modifying a company’s rating, and recently it seems only downward. This outcome may come as a result of numerous and/or multiple reasons, such as loss of equity, poor results and/or ROEs, threats to existing capital, inability to access additional capital, failure of risk-based capital testing, and lack of confidence in management – to name a few.
Results for the Canadian insurance industry appear to be showing a marked improvement for 2003. While results can certainly deteriorate during the remainder of the year, there are some companies currently with combined ratios at or below 100%. While this would obviously not be the case for all lines, it does demonstrate that underwriting discipline and rate increases have had a positive effect on results. The question that remains is how long will the discipline be maintained. Rumors have already begun to be heard about ra
te reductions. However, many believe that even slight reductions would quickly put results back in the red, if this were to occur.
Ontario auto results continue to be a concern. Improvements for many companies have come as a result of rate increases and a major effort to control growing claims costs. How much of this can be sustained with a newly elected provincial government, is a great uncertainty. These and other factors may cause reinsurers, generally, to move their participations out of quota shares and into higher attachment points.
Thus far this year, we have seen both forest fires and flooding in B.C. and hurricanes/windstorms on the East coast. While the full extent of these losses is not yet known, it is not expected that they will have any detrimental effect on available capacity or pricing, other than on some specific cases. This is also predicated on there being no other major catastrophic losses this year. The growing issue, however, from a reinsurer’s perspective, continues to be how well companies are able to identify, manage and control their catastrophic aggregates.
Earlier this year, the industry has also gained confidence with the issue of terrorism, as a consequence of two B.C. Supreme Court cases. Specifically, this relates to the “concluded ability” for companies offering all risk policies to exclude it. However, until we have a universal and/or alternative method of dealing with this exposure with certainty, it will unfortunately end up on someone’s balance-sheet, knowingly or not.
What does all this mean? Insurers are forced to have greater scrutiny in their selection of reinsurers. They must also demonstrate an increasing ability to maintain underwriting discipline and portfolio management. Lastly, they must have a greater willingness for transparency. There are fewer nave reinsurers today, greater use of actuarial sciences to measure and price exposures, increased reporting requirements and scrutiny – but most importantly, a preference to produce underwriting profit rather than simply increase volume.
Roy Vincent, senior vice president of Canadian treaties at Hannover Re
To look forward into the renewal season of 2004, we need to look backwards to the events of prior years to understand where we are and where we are going. The “perfect storm” has bruised and shaken the world market and there is a need to learn from our mistakes. We must accept as a market that we have been unable to gauge the unforeseen and price our products correctly. As a result, the world market has suffered damaging blows to its equity base, ratings and reputation. We have watched in awe at the demise of major players and the fall from grace of the most respected.
In moving to a new round of treaty negotiations, how can we achieve equanimity for both our clients and ourselves? Firstly the “unforeseen” has happened in Canada with regard to cat losses. Forest fires in B.C., and directly impacting hurricanes in the Maritimes, are not priced into our product. These events remind us this is a time to consolidate our catastrophe rates and share in the good fortunes of our clients that have also profited from primary rate increases. Pro-rata property business has started to turn a corner with rising primary rates and tightened terms and conditions. This is encouraging, although I am reminded of the words of a colleague of many years ago, “one swallow does not make a summer”. We need to be sure a sufficient margin exists to take care of a return on the capital employed, and cover our internal as well as external costs including retrocession. The longer term has produced dismal results and therefore we must press upon our clients the need to review deductibles to reflect inflation and maintain rating discipline. We cannot let up on reinsurance terms and conditions.
The main area of casualty treaties, automobile, starts a new merry go round with a change in government in Ontario. Provincial governments across Canada are also looking at everything from public auto plans, to rate freezes and roll-backs. The insurance industry has failed miserably to “get it right”. The jury is out on how far the reinsurance industry has got it wrong. The disturbing factor is that we still, on excess of loss business, offer finite pricing and give coverage ad infinitum. I think the reinsurance market has forgotten that there is a tail to the general third-party liability business. This is an area we need to address. Other lines that are mainly small in Canada such as D&O (directors’ and officers’), fidelity, surety and agriculture will continue to face further pricing and capacity pressures at the reinsurance level.
Ken Irvin, president of Munich Reinsurance Co. of Canada
The predominant pursuit in the Canadian marketplace for both insurers and reinsurers is the establishment of consistent profitability characterized by an earnings stream that is stable, equitable and sustainable to investors and all other stakeholders. Achievement of this elusive goal is contingent upon the risk-adequate pricing of our industry’s products – something competitive forces, economic cycles, and our own lack of discipline and now governments, through their political interventions in automobile insurance, seek to undermine.
In this renewal season, the emphasis in discussions with our partners will be on risk-adequate pricing of both the insurance product and the reinsurance protection we provide. If the insurance product is inadequately priced and the primary policyholder is getting an undeserved or unintentional bargain, there is no hope that we, as an industry, can come out ahead. Reinsurance will ultimately, in that scenario, be either under-priced or, following those lessons learned, unavailable.
In Munich’s own particular case, the rating agencies, although positively acknowledging our equity raising initiatives of late, have demanded that our financial model, as well as those of other leading reinsurers, produce operating results commensurate with capital market expectations – a reasonable stipulation given our significant presence in the reinsurance industry. It is therefore crucial that there be a long-term, strong and credible reinsurance market, building capital and financial stability through internally generated earnings, upon which our cedents may rely. This comes with a price tag, but for reinsurance to continue to be viable and affordable, we must prosper together.
Although there are not many new issues on the horizon this year, the industry must address its response to the positive development emanating from the Supreme Court of Canada’s decision in May, regarding the applicability of the fire part of provincial insurance acts to multi-peril policies in the common law provinces. IBC [Insurance Bureau of Canada] bulletins explain that fire-following is now not a mandatory statutory cover for such policies unless specifically written in. This is good news for the industry as fire-following coverage of events such as terrorism and nuclear is not automatic.
Pierre Michel, chief agent for Canada at PartnerRe SA
One outcome of 9/11 is the realization that insurance is not an infinite resource – the ability to pay claims is limited by the amount of available capital. Reinsurance too, is not unlimited, and reinsurers recognize that exposures assumed from the primary insurance sector must be well defined and measurable. This is the only way reinsurers can guarantee to make good on their promise to pay.
These elements have provided a degree of discipline in underwriting and risk identification during the last two years. Insurers and reinsurers alike are taking steps to clarify and quantify risk and loss potential. This lends greater transparency in insurance and reinsurance transactions. It also leads to pricing that recognizes risk exposure and the value of capital. Nevertheless, shareholders – the providers of capital – have yet to see financial returns commensurate with the “riskiness” of their venture, while rating agency Standard & Poor’s still maintains a negative outlook for the reinsurance sector as a whole. This highlight
s the complexity of the business and the difficulty in accurate risk assessment. As such, reinsurers are being scrutinized by local regulators, rating agencies, financial analysts and shareholders. Insurers, too, will be judged by the quality of their reinsurance partners.
Against this backdrop, I offer a few predictions for 2004 reinsurance renewals:
Reinsurers will maintain underwriting and pricing discipline;
Insurers will continue to gravitate toward reinsurers that offer the best security;
Risk identification will be paramount, with information and limitations on exposures playing an increasing role, both for the insurer and reinsurer;
The volatility and unpredictability of liability business will lead to rating corrections; and
Caution will underlie negotiations on automobile treaties, where product and pricing uncertainty persist in Ontario, Alberta and the Atlantic provinces.
Henry Klecan Jr. president of SCOR Canada Reinsurance Co.
Another renewal season is fast approaching and many challenges remain for reinsurers and insurers alike. Notwithstanding a slight improvement in the 2002 reinsurance results, we should remain focused on previous commitments to return to technical profitability.
There is an expectation that reinsurers will continue to exercise a disciplined underwriting approach with particular attention on poor performing portfolios. Specialty casualty business areas will be challenged as a result of changing appetites (capacity and availability) amongst reinsurers due to the relentless pursuit of “deep pockets” by the plaintiffs’ bar. For many of our cedents and consumers alike, automobile insurance throughout 2003 continues to make headlines in Canada particularly in Alberta, Ontario and Atlantic Canada. The matter has been the subject of heated debate as all interveners involved attempt to find a balanced solution to the satisfaction of all. The electorate in those provinces has sent a clear message to the respective provincial political parties – find a solution or be prepared for change. Unfortunately, a premium freeze and/or premium roll-back is not enough. The government must act to stop fraud that is rampant within the current system.
Forest fires, floods and hurricanes will add to the loss ratio for many reinsurers/insurers in 2003, although to date there have not been any severe catastrophic events in Canada.
Many reinsurers have been rebuilding their operating platforms in order to meet new challenges more effectively – I do not see this process abating for the foreseeable future due to pressures from all stakeholders.
My prediction for the 2004 renewal season: Reinsurers will require credible renewal information, every portfolio will be reviewed and rated on its own merits and performance and rate increases will be “de rigueur” for most treaties with particular attention on specialty treaties. It should be of no surprise to read that “cheap reinsurance capacity” is an anomaly of the past.
Brian Gray, president of Swiss Reinsurance Co. Canada
The underlying fundamentals have improved for reinsurers over the last two renewal periods, yet the pressure is still very much on. Many investors remain unconvinced that appropriate returns on capital can be achieved. From the perspective of clients, rating agency downgrades and security of reinsurers continue to be an issue.
In Canada, the combination of the forest fires in B.C., Hurricane Juan and the west-coast flooding/sewer back-up claims have created an above-average catastrophe year, thereby maintaining the pressure on the cost side. Against this backdrop, reinsurers are faced with the challenge of balancing two requirements – on the one hand, continuing to respond to clients’ needs and finding workable solutions, and on the other hand, stringing together several good years of earnings in order to continue attracting capital and capacity to Canada.
For property, we expect many programs to renew with little or no reinsurance price increase in 2004, though, as usual, we will rate each account on its own merits. We believe commercial liability needs further increases, at both the primary and reinsurance levels. Corrections in liability started later and have not been as strong as in property, and excess layers continue to be affected by a clear upward loss trend. Automobile working layers (up to $3 million) continue to face rising cost pressures. Reforms in several provinces should limit small claims and GNPI [gross net premium income] growth, but catastrophic claims are unlikely to be reduced (and, in Ontario, may increase).
Last renewal, asbestos and fire-following nuclear incident were key issues. There was considerable success in introducing asbestos exclusions on a widespread basis, in both primary and reinsurance contracts. However, with fire-following nuclear, several reinsurers agreed to wait a year to allow the industry to work with regulators to remove the anachronistic legal necessity of providing such coverage. Most, if not all, capital providers believe that nuclear incident is not insurable, and belongs in the same category as war. Fortunately, two Supreme Court of Canada decisions from May this year (KP Pacific Holdings Ltd. vs. Guardian and Churchland vs. Gore Mutual) opened the door for companies to stop exposing their shareholders’ capital to this peril. We believe capacity for fire-following nuclear incident is likely to dry up quickly, at both the primary and reinsurance levels. Swiss Re expects that primary companies will exclude fire-following on nuclear [covers], and reinsurers proposing contract language that provides no gap in coverage should the primary exclusion not hold.
David Wilmot, senior vice president for Canada at Toa Reinsurance Co. of America
Picture Rodney Dangerfield grousing, “long-term reinsurers just don’t get no respect”. Indeed, as industry cycles move from intense loss to modest recovery, new (read “no baggage”) reinsurers are encouraged over those long-term reinsurers who bore their clients’ losses. Consequently, reinsurers repeatedly do their clients a disservice, first by exacerbating destructive market cycles and then by endangering expectations of full reinsurance recovery years hence.
The 1980s saw the rapid growth of what later came to be known as “nave reinsurance capacity”. Money to launch new reinsurers came from steel companies, bus-lines, photocopy manufacturers and sewing machine makers. Their capital soon exhausted, these ventures disappeared – often leaving unpaid reinsurance in their wake. The 1990s saw the rise of reinsurance offices writing against their own insurance company capital. These markets helped to overheat competition, leading to the deepest period of losses in history. The companies soon realized that they were accepting substantial losses in return for the privilege of funding their competition! Not surprisingly, that cycle is ending.
The groundwork for the 2000s cycle may already be in place. We have seen sophisticated money enter the reinsurance market on the heels of recent large loss events. But, today this “new” money is no longer new. Already at the top of a U.S. pricing cycle, some of these reinsurers are now accelerating growth by entering long-tail lines of business. The sophisticated money behind these companies could do worse than plan an exit as soon as the next wave of investors knocks at the door. If Canadian property and casualty insurers want stability, they must encourage stable reinsurance. Short-term opportunistic buying will only leave Rodney shaking his head.
Cam MacDonald, regional vice president for Transatlantic Reinsurance Co.
The upcoming treaty renewal season will be filled with a myriad of issues for insurers and reinsurers alike. Privacy legislation, fire-following nuclear and terrorism events and another round of changes to the Ontario automobile product are but a few of the many challenges facing our industry. It is imperative that all segments of our industry work together to incorporate these and other important changes into our marketplace.
Although results appear to be impro
ving (for some lines of business) underwriters must remain diligent. Combined ratios are unacceptably high and there is still considerable work to be done if we are to achieve the return on equity levels anticipated by our shareholders. It was only last year that the combined ratio for reinsurers was 110%.
While there appears to be no shortage of capacity and appetite for catastrophe business emanating from the offshore unlicensed reinsurance market, the B.C. forest fires and losses from Hurricane Juan should serve to stabilize reinsurance rates for Canadian catastrophe treaties – particularly the lower layers.
Reinsurance rates for casualty excess of loss treaties will trend upward as frequency and loss costs continue to escalate leaving loss ratios on some programs unacceptably high. “Per risk treaties” will continue to be rated based on individual loss experience. The migration from pro-rata treaties to excess of loss covers will again be explored, and consideration will be given to higher retentions all in an effort to control reinsurance costs. These are typical changes in a hardening market.
With the most recent round of rating downgrades [of reinsurers], and with all the uncertainty swirling about the marketplace, the flight to quality is more evident today than ever before. Companies are seeking financially sound “A rated” reliable capacity, particularly with regard to “long tail” casualty business. Difficult trading conditions these past few years have tested the vary staying power of many organizations and this trend is likely to continue for the foreseeable future.