September 1, 1999 by Sean van Zyl, Editor
With year 2000 reinsurance treaty negotiationscurrently in full swing, there is a desperate hope among the players that rates will return to moresensible levels. However, faced with increasedcompetition, both locally and globally, reinsurersanticipate a long road ahead before the soft market cycle is broken. CU surveys the top reinsuranceCEOs in Canada to identify their strategies as theindustry moves into a new millennium.
Reinsurance company CEOs across Canada and the U.S. concur that rates have to be adjusted upward in the near future. Nearly every class of business is hovering above the “burn point” with little room to boost margins by reducing operating costs or through offsetting poor underwriting results by investment performance.
And, with increased competition from the capital markets under alternative risk transfer (ART) programs, coupled with reduced demand for traditional reinsurance capacity from primary insurers as a result of consolidation and higher retentions, the bargaining power would seem to have shifted against reinsurers. However, many reinsurance CEOs, particularly in the U.S., are hopeful of implementing a broad rate increase on 2000 treaties.
Early reports from the U.S. market do indicate a stabilization of reinsurance prices, which many in the industry see as the turning point to the cycle. That said, Canadian reinsurance CEOs appear less hopeful of achieving the same success as their U.S. counterparts, the reason being that around 60% of 1999 treaties were settled on a fixed rate multi-year basis which will not provide the opportunity for renewal for another two to three years. In addition, should reinsurers, either locally or in the U.S., attempt to push through higher across-the-board pricing, there is currently a strong sense of resistance from primary companies and risk managers to accepting such demands. A recent Conning & Company study of reinsurance buyer views suggests that attempts by reinsurers to apply any broad-based significant rate increase will be negatively received — possibly sparking a retraction from the market similar to that of the liability crises of the mid-1980s. As one reinsurance CEO comments, how buyers react to a rate increase will really be akin to “a roll of the dice” for the reinsurance industry. However, it is a roll with fate which many within the industry feel cannot be avoided.
To determine the likely direction of the Canadian market, CU approached leading reinsurance CEOs — representing about 70% of the market based on net premiums written — to identify their concerns and expectations.
Claire Gariepy, president of
AXA Re Canada.
The market is currently undervalued, and has been so for quite a while. After the January 1998 ice storm we saw rate increases in programs, however, some of these were insufficient because of the prevailing competition in the Canadian market. Essentially, this means there is no logical pricing structure in some reinsurance programs.
As far as property facultative business is concerned, we are still waiting to see some measure of good business sense, although some commercial rates are starting to rise — but there is much room for improvement. Casualty and officers & directors business also remains largely under-priced.
I hope that rates will improve in the current treaty negotiations, but the market is so small and crowded that unless something serious happens, it may well be that not much will change. The first quarter of 1999 results were weak because of the Toronto snowstorm and soft rates. Although we do not have second quarter figures, we know that on June 7, 1999 there was a major rainstorm with high winds in southern Quebec, which caused considerable damage with an estimated industry loss of $10 million. Also, between July 4 to 6, severe weather with high winds and a tornado in Temiscamingue and Drummondville, Quebec, caused an estimated industry loss of $30 million. These types of losses are not substantial enough to affect rating in a highly competitive market.
And, with so much reinsurance capacity worldwide, Canada cannot avoid new foreign competition. Reinsurance has always been an international business, combining this with corporate globalization trends will only exacerbate this trend. Emerging markets may be the future, but all companies need a stable base to grow from.
Michael Cooper, senior vice president of CNA Re Canada (CNA).
There are signs that the reinsurance market is beginning to turn and a tougher stance is being taken by some. However, improvements will be slow as reinsurers begin to react to results from prior years.
With strong financials, decent capacity, and fast response as table stakes, a very high percentage of what reinsurers presently are asked to offer in Canada is commodity business and purely price-based. The winners will be those who recognize this and cut costs, concentrating on servicing those areas requiring innovation and special expertise.
Whilst Canada is probably in the forefront of Y2K preparedness, and most insurers and reinsurers in Canada have been diligent in making their systems Y2K-compliant and have taken steps to minimize Y2K-related claims, it is possible that Y2K activity will have a certain impact. The range of potential insurance exposure created by the Year 2000 problem is sufficiently broad that it is impossible to estimate with any degree of accuracy the extent to which various types of policies may be affected. Y2K-associated legal defense costs may well be more of an issue.
As to the growth potential of ART, company CFO’s and actuaries are now playing an ever-increasing role in insurance purchasing decisions. As bottom-line management becomes ever more important, there will be a certain increased level of interest in these products. CNA Re intends to take a leading role in providing answers to our clients’ needs in this area.
Overall, Canadian reinsurers are faced with an ever-shrinking volume of traditional business. The recent trend of insurance company consolidations — which is likely to continue unabated — has led to growing surpluses, increased retentions and often a repatriation of reinsurance to the home office outside Canada. At the same time, many reinsurers need to show growth to survive and are also facing aggressive ROE demands from their shareholders. Despite this, foreign reinsurers still view Canada as a benign market where a decent return can be made. Competition will remain unrelentingly fierce. In conclusion, the long term would seem to favor those reinsurers with the largest capital and technical resources.
Peter Borst, chief agent of
Employers Re Canada (ERC).
As an individual I’m not necessarily a believer in astrology. However, as a businessman, I feel the “stars and planets” are moving into proper alignment. The conditions are right for price correction in the market.
Prices in the market are at an all-time low. There seems to be recognition of this and the need to bring prices back to economically acceptable levels. The loss experience in Canada has not been good, with U.S. property results proving disappointing, especially in commercial lines. Experience in the Caribbean, Australia and other parts of the world have also been poor. Y2K is also looming — while awareness seems high that most businesses have prepared for the impact, there will no doubt be some increased loss activity, including legal expenses.
Investment portfolio returns have hit bottom, with many insurers and reinsurers having made reserve and IBNR adjustments over the last few years — they have taken most of the capital gains available and there is little “wiggle room” left. Returns are at a low while our business’ financial monitoring skills have become precise. Capital has a clear value — its utilization is tracked efficiently and ROE expectations mean that clear targets are set for all operations worldwide. As an industry in Canada we’re not meeting those targets. As such, our plan over the short-term will be to meet with our clients, review our portfolios together and come up with a plan that will allow us both to
improve results and returns.
We hear and read so much about the changes coming to the market. Capital markets are poised to become significantly involved. Distribution channels are changing, and will continue to evolve as we look to consumer needs — in terms of both service preference and cost. As such, the industry’s merger activity will continue in the search for improved productivity, growth and brand building. As an industry we can best manage these changes by taking corrective steps early. My horoscope for the industry this coming year: act early and make sensible changes, which ensure future prosperity for you and your clients.
Brian Maltman, chief agent of ERC Frankona.
Several reinsurers have gone on record stating that continuing support of unprofitable business is no longer acceptable. How much effect these pronouncements will have in upcoming negotiations remains to be seen. With the extent of market capitalization in Canada, a sudden, across-the-board change in pricing seems unlikely, and the introduction of two and three year contracts last year will postpone some corrective action.
Some improvement may be seen, particularly if leading reinsurers stick to their resolve to base pricing on underwriting principles. Catastrophe covers are not only under-priced, but results from worldwide catastrophe events over the last two or three years continue to deteriorate, while the incidence of major weather related events appears to be increasing. The stage is set for some difficult, but necessary discussions. In Canada, the 1998 ice storm serves as a key example. Discussions on claims issues are not yet complete, and one has to seriously question the pressure to provide penthouse cover, at bargain basement prices.
Patrick King, chief agent
of Rhine Re Canada.
The reinsurance industry has been in a “soft market” for five years. Rates in nearly every class have declined, resulting in severe under-pricing on the overall portfolio. Casualty treaties have been renewed for several years at rates not covering burning cost, let alone administration expenses. The only class of business with a loss ratio of less than 70% has been the liability line at 65%. Nevertheless, the “bread and butter” property class has performed well other than last year’s ice storm experience. This, combined with investment gains, has sustained reinsurers through the “soft market”.
However, depressed rates have left no room for another large catastrophe loss. Yet we face the uncertainty of Y2K, with two catastrophes reported in Quebec for June and July this year. And, approximately 60% of reinsurance treaties for 1999 were renewed on a multi-year basis with low rates locked in for two to three years.
That said, the 1999 Midyear Market Report published by Business Insurance in July indicates that the decline in rates in London and the U.S. has stopped. The report says retrocession reinsurance rates are rising with modest firming for the 2000 renewal season. I have the same sense for the Canadian market.
While Y2K has cost untold gallons of ink and the lives of thousands of trees, it is an unknown factor for the insurance industry. My sense is that progress has been made to resolve the issue, therefore I hope there will not be a major impact on 2000 results. Reports from our cedants, intermediaries and suppliers confirm that opinion.
There were 32 reinsurance companies active in Canada in 1995. There are 30 companies today. Despite mergers and acquisitions, the market remains almost the same. However, further consolidation is occurring, which could see only 25 companies by yearend. I predict new entrants will replace those lost, so excess capacity will remain. There could be a pause in primary company consolidation next year, but I think takeovers will continue. The reinsurance programs of those acquired will most likely be merged, resulting in further loss to the reinsurance market.
Bruce Perry, vice president
of SAFR Re.
SAFR has steadily increased its portfolio in Canada for several years, despite the flattening of the market in general. With the acquisition of Winterthur Re by PartnerRe Group in December 1998, SAFR is even better positioned in the Canadian reinsurance marketplace. We have devoted much of our resources to building lasting trading relationships, both globally and in the domestic market, and have focused our recent efforts to nurturing and protecting these relationships.
There is little doubt that the market is currently under-priced, but I do not expect to see much improvement in rates in the near future. There is evidence of some “innocent” capacity leaving the international scene in selected lines and markets as the pressure mounts, leading to anticipation of improving conditions down the road. Although the ice storm of 1998 had little impact on market rates outside Quebec, it represents one of those attritional events along with several others internationally that are hampering local and global reinsurance returns. These same pressures will lead to further consolidation, which will no doubt be felt in Canada.
The true long-term players, however, are those that are determined to maintain underwriting discipline even in difficult times, protecting the capital base that is so important to shareholders and clients — our strategy is rooted in this realization. Along with a strong capital base, I feel it is important to offer expertise in specialized areas. PartnerRe emerged as a global leader for Catastrophe business a few years ago, and through diversification, is today a recognized international leader in Credit & Surety and Agricultural business, while offering several other specialty and general products. We have invested significantly in ART and are building our internal capabilities to guarantee our continued competitive position for the future, responsive to the changing needs of our customers.
John Phelan, president of
Munich Re Canada.
My outlook of the Canadian reinsurance market is for a further deterioration in results to unsatisfactory levels. This will adversely affect insurer stock prices, which are under pressure anyway.
Further cost cutting and merger activity will be necessary to improve results. However, competitive pressures will make technical corrections difficult at best. The Canadian reinsurance market is primarily dominated by a group of large foreign players — any consolidation of significance in the market will therefore be driven by activities elsewhere. In addition, the Canadian reinsurance market is habitually overcrowded and has a history of rotation amongst the smaller players, I expect this will continue.
Dominique Lavallee, president of Scor Re Canada.
The market is definitely under-priced across the lines. In all lines, reinsurance prices are at or below burning cost — commercial lines in particular. Catastrophe excess layers also do not correctly reflect either the bad loss experience we have had or the significant exposure we know exists.
Rates should improve in the coming treaty negotiations, but the impact will be limited as more than half of contracts have been renewed for over a year. As to the primary market, we have seen timid signs of stabilization in pricing of commercial business. Everyone is very much aware that under-pricing has started to reflect in deteriorating results. A selective correction should continue to materialize.
Y2K has the potential to generate much litigation. However, unless a significant catastrophe occurs, such as the interruption of electricity in one part of the country for more than a few days (which is very unlikely), the results of insurers should not be influenced too much in 2000 by Y2K.
ART and finite risk products have been available for a long time. They have not been as popular in Canada as the U.S. because we do not have the same “risk profile” — no private worker’s compensation which is the backbone of many ART products in the U.S. We also have less specialty programs. But, there is no doubt that these solutions may become more attractive in Canada as elsewhere if the traditional market hardens.
Consolidation in rein
surance will continue at the international level, with additional niche markets opening up to maintain a very competitive atmosphere. As far as the demand of reinsurance is concerned, there is unfortunately little doubt that the continued trend of consolidation will decrease it as the bigger primary clients buy less traditional reinsurance. The good news, for reinsurers, is that the primary market’s competition is being kept alive by the continued creation of new markets, which are significant buyers of reinsurance.
Angus Ross, chief agent
of Sorema N.A.
I don’t expect rates will improve with the upcoming treaty negotiations. But that is a facile response. Many excess contracts are now on a multi-year basis and those that aren’t will enjoy reinsurer competition for additional business. Where reinsurers will benefit, however, is if we see an upturn in primary rates. Because the multi-year contracts are at fixed rates, an increase in base premiums will give an unexpected boost to reinsurers developed premium – unless cedants ask for a reopening of terms and conditions
On ART and finite risk products influencing the Canadian market in the coming years, we have a couple of hurdles to cross. Firstly the size of market, at least in comparison with the U.S. and Europe, does not suggest that many deals of this nature would be available. Secondly, continuing consolidation of insurers is also weeding out some companies whose need for finite products as a balance sheet boost is greater. Nevertheless, Sorema N.A. will be looking at ART opportunities. Catastrophe bonds are unlikely to take off in Canada until we develop an accurate source of market information, such as ICS in the USA. The Institute for Catastrophic Loss Reduction (ICLR) would be an ideal repository for information of that nature. If all primary companies gave gross and net figures — confidentially — to ICLR then better market data would be available for presentation to government for statistical development and for the development of catastrophe bonds which rely on accurate market loss numbers.
Where I do believe we will see growth is in sideways (aggregate) catastrophe protections. If the first half of 1999 is any guide, we are seeing a higher frequency (not severity) of catastrophes falling below normal deductibles. Individually they might not cost a company much, but collectively they can be far worse than a single major event.
Patrick Mailloux, president
of Swiss Reinsurance
The primary commercial lines market has become unprofitable at this stage of the cycle, particularly for commercial property, and possibly for liability. Primary results may be turning around, however, this correction may be limited for reinsurers due to multi-year deals. The reinsurance market is clearly selling product below cost because of an imbalance between supply and demand (reduced due to consolidation). Particularly under-priced are proportional covers. I expect prices have bottomed out, and may begin rising this fall.
Favorable prior accident years and the realized capital gains that helped support the industry’s results are now getting thin. Insurers and reinsurers alike have had to make tough decisions in this difficult market to create shareholder value. Swiss Re does not intend supporting undervalued treaty programs as these will not develop the long-term partnerships with clients that I feel are mutually beneficial.
Other tough decisions evolve around expenses, this could result in a reduction of personnel within organizations. Operations not taking such corrective actions will likely receive a strong message from their shareholders. I do not expect foreign reinsurance competition to increase in Canada in the near term. Conversely, more and more Canadian business may wind up with foreign parents or in global reinsurance programs placed overseas. Hence, it is less a question of new reinsurance capacity moving in to capture Canadian premiums, but of Canadian premiums going to foreign capacity overseas. We will likely see the consolidation wave continue. But, with over 50% of p&c companies foreign-owned, offshore mergers and acquisitions will likely affect the Canadian non-life market more than domestic deals.
It has been argued that reinsurance is no longer a cyclical business. I beg to differ, not only is it still cyclical, but we are in one of the most difficult downturns in recent memory. There is an economic value to the protection and services insurers and reinsurers provide. The greater the extent to which prices sway from that value, the greater the correction has to be.
David Wilmot, senior vice president and manager of Canadian Operations at TOA Re.
Reinsurance rates and treaty terms appear to be at their lowest point since the late 1970s — a time when new (and naive) capacity was welcomed and super-inflation ignored. That period ended with crippling losses, the disappearance of several reinsurers, and the liability crisis of the early 1980s. When reinsurers did finally make corrections, most buyers increased their net retentions and raised their excess of loss deductibles. It is tempting to draw a comparison with today’s soft reinsurance market. Ontario’s deteriorating accident benefits and the catastrophic implications of global warming take the place of inflation. The “Americanization” of Canada’s courts and tort awards may yet awaken seemingly dormant claims of the last number of years.
Looking forward, the comparison may extend to market withdrawals, sharp adjustments in treaty terms (initiated from outside Canada more likely than not), and a new leap in treaty attachment points and retained premiums. Indeed, a number of undervalued reinsurance deals exist today for no other reason than terms no buyer could refuse.
Canadian reinsurers are struggling to preserve or increase their marketshare even as the domestic reinsurance pie shrinks through company mergers, international buying strategies, and competition from non-traditional sources. In some cases, competition has become a reckless drive for top line self-preservation at the expense of future bottom-line performance — a situation that will likely continue unabated until new strategies are mandated from abroad.
Given this soft market, the entry of a new domestic reinsurer may seem ill timed, particularly with so many treaties currently placed on a multi-year basis. However, a proper view of reinsurance dictates that “timing the market” is not nearly as important as remaining “in the market” for the long haul. Toa Re will develop business without an urgency that could further disrupt the market’s return to stability. Canadian insurers will be better served by a reinsurer seeking to develop business over partnerships and willing to measure results over time.
Cam MacDonald, regional vice president of Canadian Operations at Transatlantic Re.
My outlook for the Canadian market is one of cautious optimism, assuming that rates return to adequate levels. However, the frequency of natural disasters, fallout from Y2K, rapid consolidation and increased competition from every corner of the world are all legitimate concerns as we enter the new millennium. A considerable number of reinsurance treaties written at the beginning of this year were done on a multi-year basis. Therefore, this year’s round of treaty negotiations will have less of an impact on rates. However, for those programs up for renewal, terms will be commensurate with results achieved.
With each new consolidation on the primary company front there is often less business for the reinsurance market. Proportional programs are sometimes eliminated and primary companies often retain larger net positions. With less business to go around, I’m sure some brokers are finding it difficult to satisfy requests from reinsurance companies for more business. There is little doubt the consolidation trend will continue into next year and beyond.
As for Y2K, recent studies show that Canada is one of the most compliant countries in the world. Nevertheless, there will likely be some Y2K litigation throughout 2000, causing loss ratios to
deteriorate even further. Rates will likely increase in 2000 if these losses prove to be significant.
To date ART and finite risk products have been slow to develop in Canada. It seems most companies prefer to stay with traditional methods of risk transfer. However, as buyers become more familiar with these concepts I’m sure we will see this line of business find its place in the Canadian market. TRC has set up a separate department to deal with clients who prefer a non-traditional approach.
Overall, the Canadian market is currently well served. In the near future we may see some increased competition from new foreign reinsurance companies. However, in the long-term, the number of reinsurers operating in Canada will be fewer and fewer.
Continued on page 10.
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