Canadian Underwriter

Reinsurance Strategies

December 1, 2000   by Vikki Spencer

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The time has come, say reinsurers, for the North American insurance market to accept the rate increases necessary to sustain profitable business. Soft market conditions for the past several years may have seemed like a panacea for primary companies, but with the recent exit of CNA Re from the Canadian market, and several other reinsurers eliminating unprofitable lines of business, the price of cost-cutting is being felt.

Last year at this time, reinsurance CEOs painted a bleak picture of the industry, but this year presents a new face. And, while this year’s rate increases alone are unlikely to restore adequacy, they represent a turn toward more realistic, and ultimately profitable, underwriting.

One reason for optimism is the end of multi-year contracts signed in deference to Y2K issues. Last year, with few contracts to renew, there was little opportunity to implement the rate increases needed. This year brings more renewals and a return to more flexible, single-year contracts, say CEOs. Insurers wary of the forthcoming rate increases can take heart in the overriding opinion that negotiations will take place on a case-by-case basis, rather than the broad sweeping increase seen in other world markets.

How will reinsurers proceed in this time of transition? CU asks leading reinsurance CEOs, representing about 70% of the market based on net premiums written, to share their strategies.

Constantin Petalas, president of AXA’s Canadian Corporate Solutions.

The leading players in the Canadian market are all global organizations, and all are of course interested in staking their claims in emerging markets such as Asia and the Far East which hold the promise of future profits. But it is essential to have strong, stable bases to build on, hence the continued importance and interest in the modest size, but mature markets such as Canada. While there have been a certain number of reinsurers both entering and exiting the market in the last few years, it continues to be an important base for the truly global players.

Reinsurers will succeed in Canada in much the same way as in other markets around the world, that is, they must possess unquestioned security and strength. They must provide a full range of products and expertise, and offer recognized fields of specialization. They must be innovative and respond to changing client needs across a broad front by finding new solutions to the questions asked by corporate risk analysts. Most importantly, they will also need to demonstrate genuine commitment to long-term customer relationships, and adhere to a consistent underwriting policy. Pending a dramatic turn in the market – for which few are holding their breath – reinsurers must add to this list rigorous control of expenses, an unflinching focus on the bottom-line, the ability to draw on their global resources and skills, and the willingness to weather the bad times. These characteristics will ensure the Canadian market emerges as leaner, fitter and more resourceful.

Overall, the rate on line of most programs will increase but the insurer who has established a long-term commitment to his reinsurers, and whose renewal is basically as is, should not suffer any significant surprise. After all, this is the opportunity for reinsurers to prove their commitment and stability to their key clients.

Insurers who have not already done so, should selectively choose their reinsurer partners based on their financial strength, commitment, and consistency in underwriting. By doing so, and resisting the temptation to take opportunistic advantage of cheap capacity, they should ensure a healthy long-term relationship to ride out any short-term trends.

Peter Borst, chief agent

of ERC Group Canada.

As we enter the yearend 2000 treaty renewal season the question many buyers, sellers and intermediaries ponder again this year is, “will the market harden?”

One fact that all stakeholders consistently agree on is that returns for the insurance market have not been adequate for the risk underwriters assume. Much of the uncertainty about market hardening lies in the inconsistency in the approach of the various participants in the risk assumption business. What makes up a competitive market are the differing approaches to the timing of improvements, the degree of adjustment necessary or which business needs the most attention. There does seem to be an increasing level of anticipation that pricing correction is in the offing. The primary markets are making progress and there is some anxiety about rate increases coming from reinsurance markets.

What is interesting to me is the feeling of some reinsurance buyers that it’s an “us versus them” scenario. At ERC we don’t have that attitude at all. Our customers depend on our AAA-rated security and understand that a fair return is required to maintain that security. To do so, cedants and reinsurers have to work together to tailor a customized solution that works for both parties. Finding such solutions is not just a factor of reinsurance price, it’s a matter of considering retention levels, capacity purchased, settlement terms and primary pricing and underwriting action, to name a few. Each deal needs to be tailored to consider the individual account experience and needs.

Coming into this year’s renewal there is little doubt that top-line growth is not the area of focus. We need to focus on both the customer’s and our own bottom-line, that is what our customers expect – this is what makes good business sense.

Gerald Wolfe, chief agent of GeneralCologne Re Canada.

The 1999 reinsurance underwriting results were unacceptable by any barometer. There are a number of causes – the European storms, the large property facultative losses, but mostly it was driven by inadequate pricing in all lines. Much of it was really our fault for accepting business that was clearly inadequately priced.

Our three major segments, treaty, specialty programs (facultative obligatory agreements) and facultative are all under pressure – rating inadequacies are across the board.

The reinsurance market in Canada has lower ROEs than their ceding companies, and, with the exception of general liability/casualty, there were much higher loss ratios in lines such as personal and commercial property and automobile. After tax, ROEs are less than 5% for the Canadian reinsurance industry and approximately 6.5% for the primary industry. After the first six months of 2000, the auto reinsurance results are at an almost record high of 94% loss ratio compared to a 78% loss ratio for the primary industry. Much of this is likely driven by large commercial auto/trucking losses in both program and facultative books of business.

The commercial and personal property reinsurance results were unacceptable for 1999 and for the first six months of 2000, driven again, primarily by inadequate pricing and also by unfavorable reinsurance terms especially on quota share agreements, often driven by high ceding commissions.

Catastrophe prices worldwide have come down in several of the last six years. Prices will be driven upwards, perhaps averaging between 15%-20%, depending on the layer, the territory and the cedant’s own results. There could be isolated increases from London (so I hear) of anywhere between 50%-100%. Cat pricing is driven by worldwide results. As a result of storm losses in Europe and other losses worldwide, cat prices will be rising everywhere, and Canada is not immune.

The reinsurance market has been too soft for too long. Corrections are on their way. However, the question remains as to whether they will be adequate or sustainable over time. If inadequate pricing were to continue, many reinsurance players would likely fail and this is something the primary industry cannot afford to see.

John Kartechner,

president of Gerling Global Reinsurance Company.

The recent closure of one reinsurer’s Canadian office, and the loss of autonomy by several others, have pushed those that remain empowered to run their own shop into a state of personal survival. The message is clear: “produce the profit or you too can be a pu
ppet of the parent”.

Standard and Poor’s negative outlook on the reinsurance industry is comparable to the weatherman announcing today that Ontario’s summer has a “negative outlook”. This is hardly a forecast, but rather a look back. Personally I see sunshine breaking through the clouds in 2001 and blue skies for reinsurers for 2002.The last few years have not been good for those in the retrocession business. The frequent and severe cat losses over the recent past forced some to withdraw from this product, while others failed entirely. With the reduction of available market, the cost of retrocession will continue to rise. This has a direct impact on the reinsurers operating in Canada, even for those that purchase retrocession protection from the parent. Like it or not, we are a global business and the Canadian market will pay a (small) share for the catastrophe losses happening around the world.

We are in the same business as the primary companies and require, as they do, a certain price for the risk transfer and services that we provide. Will terms for 2001 be more favorable for reinsurers? Yes, but our approach is not to broad brush. We believe that each client must put something into the pot, but the contribution will be founded on the performance of the individual client. Will an increase in rates scare off the client? I don’t think so. Retentions may increase (if the client is willing to accept this risk) but at the end of the day reinsurers will receive a larger dollar for the risk transfer and services provided. They have to in order to survive.

John Phelan, president

of Munich Reinsurance Company of Canada.

The 2000/2001 treaty renewal season is a watershed for most reinsurers. After suffering from natural disasters globally, including the Canadian ice storm in 1998, a shrunken retrocession market has dramatically increased the cost of capacity used by reinsurers. This cost will be passed on to insurers, most of who have enjoyed very low catastrophe rates for many years. Failure to obtain reasonable rate increases this yearend will reduce the amount of reinsurance capacity available in Canada for next year’s renewals and lead to sharper corrections in the future.

The fact is that other markets in the world have become much more attractive and offer better returns on capital deployed. Canadian reinsurers can only compete for that capital by providing their shareholders with equivalent returns on their investment. Our clients understand this. They are only too well aware of the need to provide shareholders with returns that are attractive given the nature of our business. After all, performance expectations have become much more demanding for all of us and we know that non-performing units are dispensable if not quickly rehabilitated. Neither insurer nor reinsurer shareholders have much patience with sub-par performers these days – and rightly so!

I am confident that, on balance, this will be a “win-win” renewal season for insurers and reinsurers alike. Reinsurers will be able to improve pricing and terms of trade while insurers will still be able to buy reinsurance capacity and protection at very affordable prices. I expect that very few insurers will alter their reinsurance buying habits in these circumstances.

Patrick King, chief agent of Rhine Re Ltd.

The Canadian reinsurance industry is approaching the 2001 renewal season after living through four or five consecutive “soft market” years that have depressed earnings and return on equity. Declining rates on excess of loss treaties and increased commissions on proportional business, combined with a flat primary market, are creating a cumulative impact on reinsurers that is now becoming apparent on the 1999 underwriting year and, of course, on the current year.

The question is why did all of this happen? There seems to be a number of answers but excess capacity in the primary and reinsurance markets, combined with a desire to maintain or build marketshare in the face of ongoing mergers and acquisitions, may be part of the problem.

Let us look at Canada. My source shows there were 32 licensed reinsurers operating here in 1999. All are foreign owned and most of the parent entities operate on a global basis. Canada is a small part of the world market and reaps the advantages and disadvantages of its position in that market. Net reinsurance premiums written (NPW) in 1999 were $1.4 billion and the five largest companies wrote 48% of the volume. Reinsurers’ capital/surplus was $2.2 billion for just 63% of NPW, so the leverage ratio is 0.64 to 1.00. The primary market equity is now around $17 billion, which using a conservative premium-to-equity ratio of 2.5:1, produces capacity of $42.5 billion. Annualized NPW in Canada is approximately $18 billion, so the capacity utilization rate was only 42%! We can say there is excess capacity of at least 50% in the primary market and even more in the reinsurance market.

Nevertheless, the terrible results for the 1999 and 2000 underwriting years in the U.S. and Europe, and the poor 1998 to 2000 Canadian results, firmed the world market in mid-year, and it is expected that reinsurers will be looking for rate increases averaging 10% to 25% on catastrophe and per-risk covers for 2001. Insufficient, but probably all that can be achieved in one renewal year.

There is an ancient Chinese saying that goes “may you live in interesting times”. The 2001 renewal process will be indeed be an interesting time, and an opportunity to address the long-term financial strength of a vibrant and competitive reinsurance market in Canada, which is in the best interest of all stakeholders.

Bruce Perry, vice president of SAFR PartnerRe.

Insurance companies will encounter a firmer reinsurance market for 2001. Reinsurers’ returns for p&c business have been dismal, both globally and domestically. Rates and terms have been soft for far too long, and corrections are long overdue. Current (2000) reinsurance premiums quite clearly do not adequately reflect the risk being transferred.

Insurers and reinsurers face similar challenges – excessive competition, soft rates, increasing costs, over-crowded markets, demanding shareholders, pressures to maintain (or increase) marketshare. In anticipation of change, several of our clients have told us privately that they would welcome a hardening reinsurance market, as this could bolster the resolve in the primary market to implement the changes so sorely needed. One concern frequently voiced is that higher reinsurance rates would drive some covers out of the market for good. Most of the covers that would disappear, however, would be low layers of excess programs opportunistically purchased. Despite the loss of some covers, history shows that reinsurers in fact produce more premium (and lower combined ratios) when the market turns.

Another concern is that reinsurance terms are tightening in Canada due to a general tightening of the global market, and due in part to losses that have occurred elsewhere. This concern is well founded, however, Canadian insurers were advantaged during the global soft market, even after the largest loss event in Canadian history, the 1998 ice storm. The real issue is whether individual insurers are treated according to their individual merits, within the context of the greater market environment. Reinsurers make these distinctions in both hard and soft markets, so one would expect this practice to continue.

Nevertheless, insurers will face some hard decisions during this transitional market. They must distinguish between short-term efforts to gain market share and a better long-term solution. Reinsurers must take decisions too. Although capacity is great, it is not infinite. I think reinsurers will reserve their capacity for preferred clients, and for programs that are relatively better priced than others. The market may find a new equilibrium rather than defaulting to the lowest common denominator, respecting the interests of both parties to the transaction. This will not be a quick fix, one-time correction, but a step in the process that must continue over the next two or thr
ee years to have a lasting impact.

Henry Klecan Jr, president of SCOR Canada.

It should not be a great surprise to read (once again) that rates in the primary and reinsurance marketplace are depressed. This is old news and very little has changed from last year, including continued predatory business practices. This is particularly true in the commercial insurance sector where a combination of excess capital and the desire to gain marketshare have contributed to the continued downward spiral of commercial rates. Will the market see rate adjustments for the 2001 renewal period or will we, as an industry, continue to hemorrhage?

Non-life underwriting (technical) results have produced poor financial results for reinsurers over the last few years. In most instances, investment income has provided some solace to shareholders but it hardly provides the level of return that is required to maintain strong reinsurance capacity. Furthermore, is strong investment income sustainable? As an industry we must return to sound underwriting principles with a conviction towards an adequate underwriting profit margin that will justify continued shareholder support. There are a number of avenues available to reinsurers, including but not limited to cutting back reinsurance capacity (or in some instances withdrawing reinsurance support) to cedants that are not prepared to re-engineer antiquated underwriting and rating practices. However, reinsurers are also called upon to act with conviction and not provide cheap and easy capacity.

There is some justification for the negative outlook on the reinsurance industry by some analysts. Look around the market place, a number of reinsurers over the course of 2000 have already backed away from writing facultative commercial business, others have withdrawn from Canada due to poor performing commercial reinsurance portfolios as a result of poor risk selection and/or inadequate rating. The real challenge will be the ability to predict whether more capacity will be entering or exiting the Canadian marketplace in the foreseeable future. Unless there is an improvement in reinsurance underwriting (technical) results, the decision may be made for us by dissatisfied shareholders.

Should cedants panic? No, in my estimation, there should be adequate reinsurance capacity for the 2001 renewal period but not at any price and not without a renewed sense of commitment to an improved underwriting discipline.

Francois Dagneau, chief agent of Sorema North America Reinsurance Company.

It is understood and even agreed that reinsurance rates need to increase and they are. A gradual movement toward sanity would be akin to the infamous “economic soft landing”, often tried yet never achieved.

When French rates go up by 100% to 200% at renewal 2001, and all the other markets hit by a catastrophe in 1999 see substantial increases, it is difficult to talk about “soft landing”. In the absence of a major catastrophe in recent years, moderated market reactions in Belgium, Germany, and Asia appear reasonable. I think Canada falls in between, and Canadian insurers can consider themselves lucky that the ice storm occurred in 1998. Whilst one would expect the Canadian market’s reaction to be closer to what we are seeing in the markets that suffered catastrophes in 1999, such is not the case. Why are rates edging up only marginally when both insurance and reinsurance premiums need severe corrections? I would tend to blame the structure of the market. Canada is a “branch office” market with generally local underwriting teams: stringent regulatory constraints, relatively high fixed costs, significant barriers to exit, and to make matters worse, barriers to entry on a non-authorized basis are relatively low. This environment yields local underwriters who are reluctant to let business go since they fear expense problems more than underwriting losses. From the head office’s perspective, pulling out would still mean preparing annual returns for the next ten to fifteen years, and having funds withheld in Canada for a lengthy period.

Despite my pessimistic expectations about the “bread and butter” of reinsurance in Canada, Sorema has positioned itself for success by keeping very close relations with our core long-term clients. We consider niche products, show entrepreneurship and the desire to fully investigate promising opportunities by originating “project specific” quota-shares and loss portfolio covers amongst other novel approaches. In summary, the incredible tolerance of the Canadian reinsurance industry for low returns will continue to affect market results. However, this should not prevent a few successful companies from outperforming the market – we aim to be amongst them.

Patrick Mailloux, president of Swiss Reinsurance Company Canada.

Reinsurance market prices are clearly on the upswing, primarily due to reinsurers’ losses worldwide and programs coming off under-priced two or three year terms. At 2000 renewal, just over half the accounts that normally renew were available to us because of the multi-years continuing from prior years.

But after fewer renewals last year, 2001 renewal will see almost everything come due. Those coming off multi-years may have two or three years of ‘catch-up’ price adjustment to make, creating a much larger increase than would have been the case if they had had small adjustments each year.

Three broad international trends point to a correcting market. First is word that several retrocessionaires have either withdrawn some capacity or have pulled out of the market altogether. Second, a number of players have pulled out of certain lines of reinsurance. Though the aggregate of this capacity is not likely to create a shortage, the moves send an important signal that shareholders are not happy and corrective measures were needed.

Third, a number of players worldwide have pulled out of writing reinsurance altogether. Losses from natural catastrophes cost the global insurance industry US$24.4 billion in 1999. The year marked the worst on record for frequency. Taken in tandem with the severe under-pricing of the last few years, average increases in catastrophe reinsurance will likely be in the double digits this renewal.

Reinsurers are concerned that the most recent accident years are no longer profitable for Ontario auto. The industry has, to some extent, allowed itself to run at existing loss ratios because it has benefited from favorable run-off from prior years. Sooner or later, however, the current accident year will have to stand on its own and insurers will be faced with tough decisions with respect to rate levels and marketshare. Prices are down roughly 10% from Q3 1996, despite the slow ascent that started a couple of quarters ago. Reinsurers can no longer support current commission terms with the rising loss ratios.

Market sentiment is clearly such that catch-up has to happen, but how much prices are going up cannot yet be determined. As for prior years, we will continue to price every program and every layer on a case-by-case basis. A “broad brush” approach to rate increases simply does not work.

David Wilmot, chief agent in Canada for TOA Re.

The Canadian market, accounting for only 2% of the world property and casualty insurance industry, is dominated and largely controlled by foreign-owned, international insurers responding to global direction. Though insular in the past, our market increasingly recognizes the overshadowing influence of international trends and events such as the French/European ice storms and the more recent flooding in the UK. But, a more significant factor in the coming hard market is the retrenchment of capital. Much of the industry’s “recent” capital comes from less traditional sources – investors more interested in this quarter’s return on equity than in long-term insurance prospects or, heaven forbid, the glacial evolution of reinsurance value. That capital has limited patience, which has now come to an end.

By the end of 1999, shareholders could no longer sustain their poor results. Ill advised and badly executed mergers and acquisitions had eroded capit
al due to clumsy integration, expensive mass layoffs, the discovery of under-reserved past losses, and heavy culling of the very business so dearly acquired. Yet more capital was exhausted due to under-priced business and a surprising frequency of both risk and event losses. And if this were not enough, return on investment fell with declining interest rates. Still more capital dollars proved sufficiently fluid as to move easily into other investments in other industries.

Underwriters now have little room to maneuver. Margins have been depleted. Contingency funds (allowed by some European countries) have been exhausted by storm activity. IBNRs cannot be “shaved” further. Capital gains have all been taken, and the bull market may have played out. Shareholders are now demanding a return to underwriting, and they have chopped high-profile CEOs in order to make this point. Those CEOs who remain are, in turn, shouting the message to their rank and file.

Reaction in their Canadian branches and subsidiaries is less predictable, even though we probably have more correcting to do than most countries. Opportunistic but unnecessary quota shares and underlying low-retention excess treaties may disappear when reinsurers ask for corrections. On the other hand, with the use of multi-year contracts coming to an end, more treaties will be available for quoting. Expensive or disappearing retrocession markets will force both domestic and international reinsurers to allocate their limited catastrophe capacity selectively. Local reinsurers will embrace the first rating up tick seen in several years, but they will not be oblivious to the threats and admonishments of their overseas masters.

Cam Macdonald, regional

vice president of Transatlantic Reinsurance Company.

There is a misguided notion that excess capital will continue to hold back rates. It’s not the amount of corporate capacity, it’s the amount of available underwriting capacity that dictates the direction rates take. Diminishing return on equity and poor underwriting results are taking their toll prompting a decrease in underwriting capacity and an increase in rates.

Heavy catastrophe losses over the past few years are having a dramatic impact on the cost of global cat and retro covers. Couple this with the withdrawal of several retrocession companies from the market and there is little doubt that cat rates will continue to rise. Primary rates for all classes of business will also be affected as the market continues to harden.

If the cost of traditional reinsurance becomes exceedingly expensive, primary companies may seek out alternative methods of risk transfer. Finite or funded covers may gain more and more acceptance in the traditional marketplace. Some cede companies may decide to take a higher retention and/or eliminate certain segments of their reinsurance program in order to control their reinsurance costs. Rates should be increased in relation to the results of a particular program. If a reinsurance program has been unprofitable, there is little doubt that corrective measures will be taken beginning with the upcoming January 2001 treaty renewal season

Recently some reinsurers have either scaled back their operations or abandoned the Canadian market altogether. It seems clear that most companies are no longer willing to support unprofitable business. Unless there is a return to profitability, fewer reinsurers will be operating in Canada and, long-term, it appears the consolidation trend will continue. In order to maintain a healthy reinsurance market it is vital that proper rates be applied to all reinsurance contracts. A long overdue return to responsible underwriting will help ensure that underwriting ratios return to satisfactory levels.

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