Rates under pressure and insurers need to tackle contingent losses

According to a panel of insurers at the 2011 JLT Global Communications Technology & Media (CTM) conference in Salzburg, the huge losses from the Japan and New Zealand earthquakes were an earnings rather than a capital event. The insurers on the panel said they did not expect an immediate hardening of the market, although they stressed that it would only take one more major catastrophic event during 2011 to turn the market. Robert J Thomas, President, Commercial Division, Chartis International, said that rates in the US were already going up—on the energy side—up 10% in late may, he said. “Capital is moving so fluidly and fast around the world,” he said. “There will be rate increases but it will be narro—Australia, New Zealand, Chile, Japan, and known nat cat territories, some products, some exposures, some industries. But I do not yet see broad-based increases, with all products having dramatic rate hardening.”hideRichard Pryce, Regional President, ACE UK, said that insurance company results for 2010 showed that if you took out the catastrophe events and the prior year improvements, a lot of insurers were operating with a current accident year loss ratio approaching 100%. As such, he believed the market was getting close to a tipping point before the recent catastrophe activity. But he also explained that the industry moves on capital events, not earnings events. “That is why I think there will be a change for buyers but it won’t be dramatic unless you have particular exposures in the areas that have been impacted to date,” he said. “But if we have another $50bn of cat activity before the end of this year, then you would be looking at a very different market.” He added that there was another factor influencing a lot of insurance companies—the catastrophe models. He said that catastrophe modelling firm RMS has recalibrated its models causing significant changes to modelled losses, in the US in particular, and that had driven some of the pricing activity in the US. And he warned European buyers that there is a new European wind model being produced by RMS, which is going to have an impact this year. Axel Theis, CEO, Allianz Global Corporate & Specialty AG, warned that the next event ‘would bite into capital because the earnings are gone. On the reinsurance side, if we continue to see events this year as we have already seen in the first quarter, then that would be a market-changing event and rates will skyrocket’. Mark Drummond-Brady, International Chairman, Jardine Lloyd Thompson Group, said that clients do not want to see volatility and a kneejerk reaction. He noted that as markets get softer and insurers look for more ways to get premiums, ‘they will agree to relax their discipline and expand their coverage into areas where perhaps they haven’t been able to measure the exposure as well as they do in the traditional areas’. “And then something like Japan happens, and in the area of contingent business interruption (CBI), they suddenly realise how much they have given away in terms of insured exposure and the breadth of coverage,” he added. He explained that when capital is allocated away, the relaxations are removed. “The problem with a hardening market is that there will be a loss of appetite for product development and a return to technical pricing. “But if they [insurers] concentrated on providing coverages that are relevant to the buyer, then the buyer would probably pay more than they would for coverages that aren’t that relevant today,” he said. The issue of contingent business interruption (CBI) was a major topic at the JLT Forum. Peter Hacker, Partner & Global Head, CTM Practice, JLT Specialty, questioned whether CBI risk was transferable from the corporate balance sheet to an insurer’s balance sheet in a sustainable and material way. The problem is that the insurance industry does not fully understand this particular risk class, he said. “There is a clear need from the corporate side to find solutions that are sustainable and material going forward,” he said. “We cannot have an insurance industry that is undercapitalised, not covering these risks, or not getting a return. But the fundamental point is, how can we work together and properly price this particular risk...to properly identify the risk and then make sure that whatever the structure is, it adds value to the corporations.” Mr Hacker described CBI as one of the most underestimated lines of business in the insurance industry. He believes that most underwriters do not know how to rate and properly reserve CBI risk. “Not because of a lack of intellectual capacity, but because they don’t have bespoke actuarial tools for this type of risk,” he explained. “CBI is a catastrophe loss, and corporates are definitely concerned about it more than ever. But few insurers price it properly,” he said. “To properly price CBI cover you need a very good understanding of the supply chain, the crisis management, the sourcing of the company and you need models that allow you to be flexible and to consider different cash flow dependencies, or dependencies between suppliers.” Mr Theis said there was a lot of uncertainty about the level of CBI losses from the Japanese event and insurers’ exposure to those losses. “The challenge is how to manage accumulation, and the only way to do this is with clear limits, and limits related to the various levels of suppliers,” he said. He went on: “If you want the industry to write sustainable capital for additional risks to the standard property-casualty risks, moving more into the intangible asset area, then there has to be an expected return, otherwise there won’t be enough capital available. Without this there simply won’t be the access to that kind of capital. We are moving from tangible to intangible risks, such as contingent business interruption. We have to do this or the role of traditional property-casualty insurance will diminish,” he said. JLT’s Mark Drummond-Brady told the Forum that buyers of insurance were getting better and better at risk management: “It is becoming more of a science, and buyers are relying less on risk transfer and more on understanding their balance sheets, and the stress points in their balance sheets.” And he warned: “Buyers will use risk transfer opportunistically if insurers price opportunistically.”

Rates under pressure and insurers need to tackle contingent losses

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