PCI: Rates stable but concerns over reserves, regulation and profitability

“The pricing is not there and reserves are not being set at what we think is an adequate level. So we think those dynamics are going to come together sooner or later and erode capital. To this point we haven’t seen that transpire and effect ratings across the board. But we are asking people where is the reserve adequacy, where is the pricing discipline,” Anthony Diodato, Group Vice President at credit rating agency AM Best, told CRE's partner publication Reactions this week during the conference. AM Best estimated that there was around $2bn of reserve redundancies at the end of 2009. But this estimate was based on year old figures, said Mr Diodato, and this figure is likely to have been eroded. “We do think that current accident years are the ones that are deteriorating, companies have been very aggressive in taking accident year results down and that is where our concern is,” he warned.hide“It is going to be a problem...There is a gap there and someone is wrong. Sooner or later someone is going to have to pay the claims and it is going to come back into insurer results,” he warned. “They might have good results now but the ones with longer tail business, that is underpriced, are the ones that are going to be more of a concern from our perspective,” warned Mr Diodato. Both AM Best and rival rating agency Standard & Poor’s said this week that they did not expect rates to turn in the foreseeable future, barring a large trigger event, with rates continuing to decline at Jan 1 renewals and into 2011. The primary insurance market is likely storing up problems as it writes business at increasingly competitive prices, experts agreed. “One of the most meaningful developments in the market is that insurers have come into the market and were able to write risk at more competitive prices than the facultative reinsurance market was able to,” John Daum, Executive Director at Lockton Re told CRE's partner publication Reactions. “So the reinsurance market has been fairly disciplined whereas the primary market, it is not that they have been running amok, but it has been much more competitive and people have been willing to follow the market down further than the reinsurers,” he explained. Patrick Hartigan, Head of the Reinsurance Treaty Team at Beazley, said that the insurance industry needs to seriously consider how long this can continue if they want to attract investment capital. “I think the insurance industry seriously needs to think about whether it can still maintain and attract investor capital while showing deficient underwriting results. Because you are getting no underwriting gain and precious little in the way of investment income,” he warned. A further worrying trend has seen insurers ceding less to reinsurers in an attempt to grow their top line in the current rating and economic environments, experts agreed. “They (insurers) all tend to have fairly high retentions now so they are exposed to big net losses if they were to have a loss...They are retaining more business, they are writing at lower prices and their investment income is virtually nil – so it doesn't seem there is a lot of margin for error,” said Mr Daum. Mr Hartigan also pointed out that there is a trend towards greater frequency of reinsurance losses above the $1bn market loss as medium sized losses for the industry increase. He also said that discussions over a possible takeover of fellow Lloyd's insurer Hardy Underwriting by Beazley are ‘ongoing.’ And Mr Hartigan also warned that increased regulation is cutting into the insurance industry’s earnings and that buyers of reinsurance should prioritise credit quality over price. “There has been a fair amount of loss activity this year. In Chile for example we saw an $8-$10bn loss and most of it will be reinsured. The New Zealand earthquake, Australian hail storms, both in Perth and Melbourne, the central and eastern European floods and windstorm Xynthia have all caused losses,” Mr Hartigan said. “So, all in all, the environment from weather related losses perspective is getting worse. And the frequency of medium sized loses, both in US and internationally, seems to be deteriorating. So if we see any trend it is for greater frequency of losses above the $1bn market loss,” he said. And regulation is also cutting into the insurance industry’s earnings, he pointed out. Solvency II could well be followed by regulatory equivalence in the US and Asia, he said. And regulation from the financial services, that are primarily looking to introduce a stronger risk management environment in the banking industry, will also affect the insurance industry, he said. This will increase the burden on the industry, adding to expense ratios, he said. “So combined ratios are naturally increasing,” he added. Mr Hartigan believes that the reinsurance industry will remain disciplined at renewals. And counter party credit quality should be top of the reinsurance buyers’ list rather than price, he added. “I think the market will be disciplined, but if new capacity does come in then it will upset the balance and the only differential that a new insurer coming in will have is in terms of pricing,” he said. “And this begs a question from buyers about whether you opt for reinsurance price or counter party credit quality. I think most people would talk about the credit quality of being of upmost importance because reinsurers recoverable are a significant liability on people balance sheets. So quality is key and I think you cannot push rates to an extent where you reduce the quality of the product,” he added. On the issue of Beazley's proposed takeover of Hardy Mr Hartigan said that discussions are ongoing. Beazley made an approach for fellow Lloyd's insurer Hardy Underwriting last week, valuing the target at £156m, which Hardy rejected. Beazley has said that it will approach shareholders of Hardy in the hope that it can persuade them to accept an offer. “They are complementary businesses. Hardy has more of an international book whereas our portfolio is 60% US based, so you immediately get diversification benefits. There are capital benefits to be had, the businesses are compatible and culturally [the two businesses] are a good fit,” he added.

PCI: Rates stable but concerns over reserves, regulation and profitability

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