News and Views on Reinsurance

A.M. Best executives agree a change is needed to harden the market and a major catastrophe could make that happen

A.M. Best executives (from left) Robert DeRose, vice president of reinsurance; Greg Reisner, senior financial analyst; Jackie Catrino-Lenz, financial analyst; and Jeff Mango, assistant vice president.

Canadian Insurance Top Broker spoke to four A.M. Best executives in a conference call, including Robert DeRose, vice president of reinsurance; Greg Reisner, senior financial analyst; Jackie Catrino-Lentz, financial analyst; and Jeff Mango, assistant vice president.

Here are some of their insights on the state of the reinsurance market today.

Q: What are some of the current issues and trends in reinsurance?
A: Excess capacity globally. No matter where reinsurers operate, there is more capacity shaping a shrinking reinsurance demand. That has led to erosion in pricing. The erosion has been more prominent on the casualty side than on the property side and this has resulted in reinsurers adjusting their risk portfolios towards shorter tail property classes of business, and avoiding casualty or longer tail risks. Also, this has translated into deteriorating bottom-line performance coupled with lower investment yields. However, despite the negatives, overall profitability has remained, and is attributable to the favourable reserve development of prior accident years.

Q: How would you characterize the state of the market in Canada?
A: The Canadian market provides a level of diversification that is attractive to global operators. As far as how business is performing in Canada, it aligns with the global market. The excess capacity that is in the global market is chasing whatever demand exists in the Canadian market, so prices are competitive in Canada as they are globally.

Also, catastrophe modelling firms are expected to launch a model revision in March 2011, which is expected to put more weight on inland exposure. This means that primary companies might find they have more catastrophe exposures than they previously thought, and this could potentially increase the demand for reinsurance in Canada. This is affecting New England, and could also affect the eastern coast of Canada.

Q: What will be the impact of OSFI’s new B3 guidelines on sound reinsurance practice?
A: There is increased regulatory rigour around reinsurance buying and more transparency. The regulator wants to have a better handle on what primaries are doing when purchasing reinsurance and performing their own credit analysis. We don’t have a crystal ball, but as an outside observer, that could potentially cause the primaries to diversify their reinsurance placement. This could play well for some reinsurers that up to this point haven’t had a significant position in the Canadian market.

Q: What are the biggest market challenges?
A: The competitive marketplace and soft pricing coupled with the low investment yield have put a lot of pressure on underwriting. This is due to the soft market conditions that currently exist. The most probable cause for change is a major catastrophe, which would take the excess capacity out of the global market place, and this in turn would drive a hardening market in Canada and around the globe. In the meantime, what you’re seeing is reinsurance companies decreasing their premium volumes so they don’t take on underpriced risks that will be costly down the line.

Q: What is the pricing environment like?
A: It’s soft for casualty, but property is also eroding. Property still has a level of adequacy to it so there are some opportunities, but casualty has been running at a loss for the more recent accident years. For property, you might see individual primary carriers have different responses. There have been catastrophes in the Canadian market in isolated areas, so some primaries might see some pressure on retention or pricing. The whole market is very competitive.

Q: How are the financial results?
A: The Canadian market has been profitable. The five-year average combined ratio for the marketplace has been about 95, generating high single-digit total returns on equity. It’s been stable over the longer term. Certainly this means the Canadian market has been profitable from an underwriting perspective. Also, investment yields have been close to 4%. This looks like a healthy return on investment.

Q: What is the impact of the low interest rate environment?
A: It has depressed the bottom line. You would think that with lower investment returns, it would put more pressure on underwriters to price the business more conservatively, or to a higher profit margin, but we haven’t seen that dynamic emerge yet. It seems that the only thing that’s going to turn the market is a catastrophic event. The probability that will happen during the first half of the year is less than in the second. Hopefully the worst of winter is over. An earthquake can happen at any time and any place, but we’re probably waiting for a major wind (hurricane) event to change the market.

Q: How have companies positioned their investment portfolios?
A: Very conservatively. Since the financial crisis, we’ve seen companies go towards fixed income portfolios with a shorter duration. They’re hedging their position against the possibility of a rising interest rate. Overall, we think they’re defensive right now. As things start to stabilize, we would expect to see companies gradually opt towards more riskier asset classes.

Q: How is reserve adequacy? Are there any concerns regarding the balance sheets of companies?
A: A lot of companies continue to believe that their reserves are redundant. We’re skeptical at this point as favourable reserve development has exceeded our expectations. It’s fair to say that some companies reserve more conservatively than others, so it’s not even across the board for all companies.

There isn’t any major concern regarding balance sheets. Reserves seem to be adequate, though the cushion isn’t what it was two years ago. Most companies are in a healthy excess capital position so if there are any hiccups, they’re well positioned to absorb that.

Q: What is A.M. Best’s outlook for the global non-life reinsurance market?
A: We have a stable outlook, and have had one for the last five years. What’s supporting that outlook is the excess capacity on most balance sheets. Even though profitability has compressed over the last few years, there is still plenty of capital to absorb adverse conditions.

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Copyright 2011 Rogers Publishing Ltd. This article first appeared in the March 2011 edition of Canadian Insurance Top Broker magazine.

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