Remnants of Change

As always, the reinsurance market here in Canada and around the world remains in a state of change, with reinsurance companies constantly working to reinvent themselves by holding firm to what has worked in past, but also innovating to address what may become part of the future landscape. Central to this mix of old and new, undoubtedly, will be how reinsurers maintain, and perhaps build on, existing relationships with clients.

While the natural catastrophe experience to date in 2014 has not packed the obvious punch of 2013 – a year in which Canada witnessed its largest-ever tally of insured losses – it has not been without its hits. And there is no guarantee a year of relative calm will be followed by another.

It is in this seemingly quiet environment that relationships will be tested. Beyond ongoing challenges – among these, declining rates, the low interest rate environment, the influx of alternative capital, abundant capacity, regulatory change and broader terms and conditions – there is an increasing demand for innovative solutions. How will reinsurers need to respond (and what will they need to offer) to maintain existing relationships with clients? What will be the effect of insurers retaining more risk? Will things change with a big catastrophe or a string of benign catastrophe years?

Canadian Underwriter asked senior executives of reinsurance companies operating in Canada what they see ahead for 2015. What effect will all this change have on the look of the reinsurance market here at home? 

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

In 2001, the planet was reeling from the terrorist attack on the World Trade Center. At the time, it appeared that the reinsurance market would harden and that Canada was not immune to global forces. That view was meant to alert buyers to what could be forthcoming.

Circumstances could not be more different today. The global market has not suffered a noteworthy catastrophe since 2011 and is drowning in capital.

Traditional writers boast an all-time capital high of more than $300 billion and three times that amount is available in insurance-linked investments amidst the more than $30 trillion in global pension funds. Risk-free yields are artificially depressed and deferred in a financial world that has yet to emerge from quantitative easing. Investors are scrounging for acceptable returns and have discovered reinsurance.

The GC global cat rate index is down by 17% this year and by more than 40% since its post-KRW (Katrina-Rita-Wilma) peak of 2006.

Furthermore, the 16 licensed reinsurers in this country are all suffering from a lack of scale and towering minimum capital test (MCT) ratios. Distribution in Canada, which was essentially down to two major reinsurance intermediaries, is perking up as the second tier curiously invests.

It is a fascinating and unprecedented period for everyone in the Canadian reinsurance business and it should deliver incredible opportunities to astute buyers.

2015 should bring rate reductions, multi-year deals, quota shares, and new underlying layers like never before. Buyers will be enticed and invited to buy more cover for less premium. The net cost of reinsurance (premium less recoveries) will likely be dipping to neutral or negative.

Let the games begin!

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

At this time last year, reinsurers were all lamenting the dreary year being handed to us by Mother Nature. Things definitively look brighter this year, regardless of a poor start of the year with a brutal winter and rapid thaw. Summer storms avoided heavily populated areas, and losses mostly avoided reinsurance layers.

Although 2013 may have been an unlucky year, the gods were smiling on reinsurers and the industry for 2014. And one is left to ponder the following questions: How much more would the Airdrie hailstorm in Alberta have cost if it had hit just 30 kilometres south? How much more would the Burlington, Ontario storm and sewer back-up have cost if it had hit just 30 kilometres northeast?

Major events will keep happening in Canada, so the industry must continue to engage stakeholders in prevention. And insurers and reinsurers must also remember to expect the unexpected!

Introducing actual cash value (ACV) on roofs in Alberta is great, until the next severe hailstorm hits Montreal or the Greater Toronto Area. How many of those roofs will be at ACV?

Capacity will be available for Canadian programs this renewal season. Between this capacity and a quiet catastrophe year, pricing will generally be coming down, regardless of the latest wind peril model change. Advances in prevention and mitigation, as well as changes to policy wordings, may just help keep those price reductions permanent.

Other lines of business will also come under pricing pressure. Capacity is chasing a decreasing pool of premium, thanks to industry consolidation. Over the coming years, however, consolidation will not be restricted to the primary side.

Ceding companies will be well-advised to select reinsurance partners with superior ratings and that are committed to the Canadian marketplace.

3 Tim Fisher
Canadian Branch Manager
XL Group – Reinsurance

With the first of the submissions for the January 1 renewal season starting to appear in reinsurers’ inboxes, a review of current insurance and reinsurance market conditions may help provide context for what is likely to unfold in the Canadian market for 2015.

1. underwriting performance remains weak – the average combined ratio over the last five years for Canadian domestic insurers is 101.9% and 95% for reinsurers;

2. yield on “new” money has reduced – recent volatility in financial markets has weakened investment income, reinforcing the need for disciplined underwriting in both primary and reinsurance markets;

3. competition is intense – in the primary market, margin has been lost due to reduction in Ontario auto rates, the increased application of predictive analytics is benefiting companies able to leverage their data advantage while reducing margin retained within the market and outside personal lines, and the “small” in the small and medium enterprises segment rate levels appear stagnant;

4. capital markets influence – it appears that no domestic Canadian insurers have accessed this alternate source of capacity, but it seems likely larger buyers compare the economics relative to existing structures;

5. broker changes – as significant individuals move from one reinsurance broker to another, the short-term impact on broker margins is likely to be muted, but in the longer term, as incumbents defend and competitors seek to win business, the cost brokers charge for very similar services will likely be a key factor in client decisions; and

6. Canadian reinsurers – the average net underwriting profit generated by local units of global reinsurers during the last five years was $75 million annually, meaning the contribution to their respective shareholders is modest, but the volatility assumed is significant.

Overall, all segments of the insurance and reinsurance market face significant challenges in 2015. The weak combined ratio of primary markets will not be changed significantly as a result of changes to reinsurance pricing, with increases in original rates likely the key ingredient required to reduce ratios to the low to mid-90%s.

This, combined with lack of investment income, points to the necessity for disciplined underwriting and a resultant stable market for 2015.

4 Caroline Kane
Senior Vice President & Chief Agent in Canada
Toa Reinsurance Company of America

Having endured one of th
e worst years on record in 2013, reinsurance industry results for the first half-year 2014 reflect a marked improvement.

While many parts of Canada endured a severe winter, which dampened primary industry results, most of these smaller catastrophe losses did not breach reinsurance attachment points.

Nevertheless, the increase in frequency of weather-related losses, coupled with aging infrastructure, population density and concentration of high values is straining the re/insurance industry.

Mitigation of catastrophe losses will require further calibration between various levels of government and the industry. Reinsurers need to work with their clients (cedants) to better understand changes in underlying portfolios that affect both modelled and un-modelled risks.

Capacity within the Canadian marketplace is plentiful and there are several issues that will pose a challenge to reinsurers going into the 2015 renewal session and beyond.

Firstly, structural changes to certain reinsurance programs – a shift from domestic to global placements, plus the use of alternative forms of capital – will continue to erode the premium base in Canada. Secondly, primary insurers are likely to continue to retain more risk. However, this trend may well reverse should, for example, the industry see inflation increase, thus influencing claims costs on medium to long tail business. Thirdly, there will likely be a slight erosion of reinsurers’ profit margins due to competitive pressures.

However, inflation and/or an unexpected jump in loss costs and/or a significant event, either catastrophic or systemic, would stabilize price adequacy.

Pressures on pricing, terms and conditions will always be part of the underwriting cycle. However, preservation of capital is paramount.

It is critical that reinsurers manage the cycle while exercising underwriting discipline in obtaining adequate pricing for the risk return.

5 Henry Klecan
President & Chief Executive Officer
SCOR Canada Reinsurance Company

Much time has been expended in the last several months discussing, reviewing and analyzing the state of the reinsurance market both domestically and globally, including the impact of alternative capital solutions entering the marketplace.

Suffice it to say that the reinsurance market is in good health with ample capacity to meet the needs of its cedants.

But, is that enough? What do cedants expect of their reinsurance partners? With a continuing consolidation of reinsurance programs, the role of the reinsurer is changing along with the world of risk.

Sophisticated cedants are increasingly interested in selectively choosing their reinsurance partners and limiting their number in order to minimize their counterparty risks, including related monitoring costs – i.e. tiering. Why?

There are several drivers: reinsurance is more than just a risk transfer mechanism; it is now being viewed as a long-term risk and capital management tool. Corporate governance is pushing this change with increased centralization and the involvement of senior management, including boards, in choosing their counter party partners. Quantitative tools are being utilized to assess the needs and assist in the decision-making process through sensitivity analysis.

Streamlined and agile organizations that can react quickly to a changing risk environment and take advantage of available analytical tools in assessing risk will be ahead of the curve and bring value to the cedant/reinsurer relationship.

The risk of global pandemics, cyber threats, terrorism and climate change are very real. However, solutions to these growing risks are not exclusive to the insurance/reinsurance sectors.

The Canadian insurance/reinsurance industry is encouraged to proactively continue existing dialogue with all levels of government and consumer groups to improve the understanding of the inherent risks associated with the evolution of risk per se.

The 2013 floods in Alberta certainly underscored the poor preparedness for such catastrophic events. Let us also not forget about the potential for a severe earthquake on the Canadian west coast and the enormous financial impact that such an event will have on the Canadian economy and individual lives.

6 Patrick Li
Vice President, Canada
PartnerRe

The year 2015 is shaping up to be a challenging one for reinsurers. Market dynamics are unlikely to change in the foreseeable future with pricing softness as a result of excess capital, abundant capacity and competition among reinsurers looking to diversify their portfolios away from catastrophe perils zones.

There is also a push in the Canadian market towards catastrophe bonds (insurance-linked securities, ILS). This product has grown tremendously over the years, especially in the United States and it is very likely that large national companies will buy some form of ILS in the very near future – thus increasing competition for reinsurers from the non-traditional market.

Reinsurers also expect the primary market to consolidate further through mergers and acquisitions. This will impact the reinsurance market, which will continue to shrink as reinsurance programs become consolidated either locally or globally. The 17 reinsurers that have local offices in Canada will be battling for their share of a shrinking market.

In spite of this tough environment, cedants are still looking to partner with reinsurers that can leverage their specialist expertise and in-depth understanding of their markets to come up with innovative risk solutions. Unlike the alternative capital providers, reinsurers remain uniquely positioned to do this.

Weather, for example, will remain a top issue for insurers in 2015.

There is some concern about affordability of homeowners insurance in Alberta following years of weather-related losses, as rates have increased significantly and coverage is being narrowed.

Reinsurers that understand this market and are responsive to the needs of their clients will be well-positioned to support the local market with a customized product for hail and wind losses.

Overall, it is a tough market for reinsurers, but there remains a unique role for reinsurers that are able to effectively partner with their clients to provide appropriate risk management solutions.

7 Cam MacDonald
Senior Vice President & Chief Agent (Canada)
Transatlantic Reinsurance Company

Reinsurers can expect another challenging year ahead with continued downward pressure on terms and conditions, higher retentions, less pro rata reinsurance purchased and another round of mergers and acquisitions activity.

The reinsurance marketplace is a very mature and competitive environment and it will take all of reinsurers’ technical ability and considerable business acumen to navigate through these difficult times. There is very little (if any) profit margin left on some accounts, and with interest rates at historically low levels, there is (or should be) increased demand on underwriting profit.

Reinsurers must be willing to walk away from unprofitable business or suffer the consequences.

Building stronger local and global relationships, identifying client needs and providing product line diversification beyond traditional reinsurance arrangements is a must for reinsurers if they wish to remain relevant.

New opportunities may include flood coverage on personal property, cyber coverage and nuclear liability, while regulatory changes relating to capital adequacy may require some companies to purchase higher property catastrophe limits.

Water-related catastrophe losses are appearing with greater regularity and there is every reason to believe this trend will continue throughout 2015 and beyond.

On a positive note, the market is actively addressing the water damage issue and has made significant strides in mit
igating future loss from water-related claims.

There has been considerable chatter in the marketplace about seemingly endless capacity from “capital markets” and while this at times naïve capacity may in the short term add another layer of pressure on pricing, traditional reinsurers and their clients still value local, long-term relationships – and for good reason. The most enduring reinsurance partnerships are built on trust and longevity, not opportunism.

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

The January 1 renewal is expected to be a difficult one as a result of the worldwide soft market, significant capacity and capacity that continues to flow in the direction of Canada.

The flooding in southern Alberta and in and around Toronto in 2013 were handled, more or less successfully, at January 1, 2014 renewals. Losses so far this year, including the hailstorm in Airdrie, are not expected to have a proper reflection in the rates.

As such, there is a lot of pressure on pricing and companies are still thinking about increasing retentions.

With the insurance-linked securities (ILS) capacity coming into the market, it will continue to be important for reinsurers to differentiate themselves from those capital markets.

While smaller reinsurers that mainly play on catastrophe programs only might be more easily replaceable by the alternative capital, reinsurers who can play across all lines must demonstrate that they are not looking for payback in a year or two, can see the bigger picture and can emphasize the approach in long-term customer relationships.

ILS markets are not likely to go away. Reinsurers must respond by being very clear in their selling proposition that there is more they can offer than purely the capital.

Reinsurers did not overdo it last year when they were asking for rate increases and it will be interesting going forward to see how clients will react, that they continue to partner with reinsurers despite capacity being available from markets that did not sustain losses flowing from events last year.

But the strong relationship in Canada between cedants and the reinsurers – which is different than many other markets, especially the U.S. market – makes clients less opportunistic, seeming to value and support the long-term relationship.

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

As reinsurers head towards the end of 2014 and start looking forward to 2015, the outlook for the upcoming renewal season is guardedly optimistic.

The catastrophe activity during the year was relatively moderate, led by the extreme wet weather in western Canada, resulting in a further barrage of water losses.

Insurers and reinsurers across Canada continue to be faced with the challenge of addressing flood losses and a way to develop a flood-mapping strategy, provide adequate cover and charge an appropriate premium.

The insurance community will rally to develop the solution, as the onslaught of water losses will clearly continue to affect the industry in the future.

The Ontario automobile scenario for 2015 remains volatile and concerning for reinsurers as reduced primary premiums are now earning and reinsurance rates will follow. The results, driven by the loss severity facing reinsurers, will no doubt be under strain as the new bill introduced to reduce claims costs address frequency and fraud, not severity.

With respect to the investment climate, the volatility continues. Through August 2014, the equity returns were stellar, but September and October brought significant correction. Fixed income portfolios face great interest rate risk and force shorter duration with poorer returns.

The emphasis on underwriting results must be paramount.

All in all, the reinsurance capacity continues to grow, driving expansion into new lines and new markets as reinsurers strengthen their diversification and spread of risk. There is also an abundance of new capacity that has entered the market, whether through conventional markets or insurance-linked securities, placing further pressure on pricing across the board.

The efforts to deploy capital will maintain a competitive, but stable renewal season as reinsurers strive to maintain and possibly gain market share.

10 Eric Steen
Executive Vice President – Reinsurance
JLT Re

Alain Perreault
Executive Vice President – Reinsurance
JLT Re

The competitive pricing and tone in the reinsurance space remains that of a buyers’ market. The remainder of 2014 and likely into 2015 will be that of fierce competition for the premium that comes from those who are reinsured in Canada.

The lone caveat is natural catastrophe aggregation and how much reinsurers can manage to hold without jeopardizing their position from a regulatory or modelled peril standpoint.

Capitalization continues to be extremely strong and indications from the latest figures would expect that this trend will continue for the remainder of 2014.

For primary insurers, there is no shortage of existing capacity. The reinsurers range from the extremely well-established, multi-billion-dollar participants to the relatively newer and smaller-sized entrants who want to take a piece out of the ever-shrinking Canadian ceded pie.

Capital markets with an appetite for Cat bonds present a new threat to any possible stabilization in market terms or pricing.

The absence of a meaningful size natural catastrophe domestically or globally will keep the renewal market very competitive. There is, and will be, an over-capacity for catastrophe coverage for the foreseeable future.

It will take a catastrophe event at a scale like no other the industry has ever seen before to occur for this continued competitive environment to change.

The casualty business represents new growth opportunities for many reinsurers. However, with their entry into this space, it will create competitive pressures to further market softening.

The financial position of Canada’s insurance and reinsurance industry is extremely strong and though competition may look to be coming from everywhere, this allows for the best to be creative, client-focused and look at ways to add value for the products they provide.

11 Jonathan Turner
Chief Financial Officer
Swiss Re Canada

Recent events in Canada, North America and around the world have emphasized that a significant gap often remains between the insured losses and the economic losses following a catastrophic loss event.

In Canada, the Alberta floods in June 2013 are estimated to have caused $5 billion of total damage, with only $2 billion or so of that being insured/reinsured. Similarly, the Greater Toronto Area thunderstorm barely two weeks later led to economic damages that are 1.5 times the insured losses.

Last year’s study on earthquake losses by AIR Worldwide resulted in an even more sobering view – a magnitude 9.0 earthquake would be expected to cause $75 billion of economic losses, with only $20 billion being covered by insurance; a magnitude 6.1 earthquake in Quebec City could cause a $61 billion hit to the economy.

The public and private sectors have a shared responsibility to mitigate the risk of wind, water, fire and quake.

On the private side, insurance helps home and business owners rebuild and recover from a disaster, while on the public side, governments need to protect their investments in public works, infrastructure, emergency response and social services – which can be compromised, or even worse, obliterated, by wind, flood, fire and tremor.

Other nations are beginning to recognize that is not necessary to ask taxpayers to foot the
entire bill or sacrifice other important programs to rebuild roads, bridges and levees and restore emergency response services.

Mexico, for example, is tapping the risk diversification capabilities of the insurance and capital markets to reduce the financial impact of these events.

By selling some of the risk to private investors, governments reduce their unexpected financial risk.

These solutions also give government decision-makers, for the first time, an independent market-based estimate of a nation’s climate and weather risk.

By putting a price tag on unmitigated risk, a government can make more educated decisions in how to allocate its financial and human resources towards risk prevention.

12 Philipp Wassenberg 
President & Chief Executive Officer
Munich Reinsurance Company of Canada

For the upcoming January 2015 treaty renewals in Canada, the economic environment is dominated by strong competition, mostly fuelled by extremely low interest rates and the perceived lack of higher yield returns in other investment areas.

However, this attraction will prove short term because reinsurers who are too hasty to compete aggressively for commoditized business and market share will pay a high price later. Risk adequate pricing remains key for those who want to be around in the long term.

While pricing is tough, a prosperous future for the reinsurance market is still anticipated. Overall, at least a moderate rise in demand for property and casualty reinsurance is expected in the medium term, prompted both by increasing insurance penetration and rising values of material assets.

There also appear to be new opportunities for long-term profitable growth in emerging risks from technological or societal trends, and increasing environmental and weather risks. These will require inspired and innovative insurance solutions.

The lack of flood insurance in Canada is one example; earthquake is another. Only a high market penetration will provide the economic capacity to recover quickly after such disasters.

Reinsurers must ask themselves whether the current situation is “just” another cycle, as has been seen before, and whether the industry should just ride it out, as it has done before. Or have these changes now become permanent, requiring a radical change in strategy?

Many aspects of life are becoming increasingly uncertain, which is especially worrisome for insurers who want to provide foreseeable and stable results to their shareholders.

This would seem to be the perfect rationale for outsourcing unforeseeable events, unaccounted for accumulation scenarios, result volatility or merely the increasing burden of capital cost, to global reinsurers with much more diversified portfolios.

Such uncertainty creates opportunities for those with superior analytics, resources and creativity. Reinsurance, in particular, has to reinvent itself in order not to be marginalized as a pure commodity provider in the end.

13 Matt Wolfe
Senior Vice President & Managing Director
Beach and Associates

Reinsurers need to realize the challenges they are facing right now are largely cyclical problems, and the really troubling news is that structural changes are emerging that will likely permanently alter their marketplace.

The cyclical challenges are evident to all: cedants are electing to retain more business net and/or placing consolidated reinsurance programs at the group level to reduce spend. Consolidation continues to see smaller insurers, who relied heavily on reinsurance, acquired.

This reduction in demand for reinsurance, particularly for non-property-catastrophe covers, has had the expected result on pricing, terms and conditions.

Reinsurers’ overall ceded premium volumes have continued to shrink, in spite of increased demand for property catastrophe limits due to regulatory requirements and changes in modelling outputs.

The structural change that is slowly coming to the Canadian reinsurance market is already well under way in the United States reinsurance market. Alternative sources of capital, primarily from hedge funds and pension funds, have decided that property catastrophe reinsurance is an asset class in which they wish to invest as these events do not correlate to financial events.

The improvement in data quality and the commercial availability of analytical tools that facilitate pricing in recent years has essentially commoditized property-catastrophe reinsurance pricing, allowing these markets to enter the space and compete competently with traditional reinsurers.

If property-catastrophe reinsurance has become a commodity, and alternative vendors are prepared to sell it at returns that reinsurers may not find viable over the long term, what should reinsurers do? They need to identify areas where data is limited or imperfect and where analytical (pricing) tools are not easily available for purchase.

Emerging risks such as flood, cyber, nanotechnology or even the commercial use of drones cannot yet easily be priced by a computer model; it takes intelligent underwriters who are prepared to make decisions and take calculated risks.

This is where the reinsurance industry can generate strong returns and provide a valuable service to the overall economy.