Insurers in a Dangerous Time

Following one of the worst hurricane seasons on record, cat claims may not be as bad as initially predicted, panelists told industry members gathered at St. Pete’s Beach, FL, for the 7th Annual North American Insurance Conference.

The conference highlighted discussions regarding how the events of 2005 would impact the future of the industry at large. Speakers noted the triad of hard-hitting hurricanes – Katrina, Rita and Wilma – had a definite impact on the industry and the financial state of insurers and reinsurers. How the industry will cope, clean-up and move on will depend on a myriad of issues, many of which key players discussed at this years conference, hosted by Kingsway Financial Services.

CAT CALLS

The hurricanes that hit the Atlantic in 2005 signified, from an insurance point of view, catastrophic economic events. Panelists however, explained that the repercussions weren’t merely economic. Ernst “Ernie” Csiszar, president of the Property Casualty Insurance Association of America (PCI), pointed out that one of the biggest issues resulting from the storms is domestic security.

Many policyholders felt an inadequate response was provided for the severity of the situation, Csiszar said. “Events like Katrina change everything,” he said. “Repercussions such as unconfident consumers will stick with us for a long time – definitely through 2006.”

Coping with consumers is on the agenda, Csiszar said. But in order to move forward after Katrina and the resultant financial “hiccups,” the bigger question now, according to him, is: “Do we develop backstop programs?”

It has not yet been determined whether or not a federal backstop should only be available within states where a state cat fund already exists, he said, and whether it should be made available for all catastrophic events. “The huge problem we (the insurance industry) are now facing is how to mitigate what no longer seem to be just ordinary catastrophes,” Csiszar said. “They’re actually becoming mega-catastrophes.”

REINSURANCE REVIEW

As a result of the worst hurricane season ever recorded, reinsurers’ reserves have dwindled, meaning that if another Katrina-type cat strikes, successfully managing – or even financially surviving – the event may be equivocal.

In order to ensure fruitfulness in the face of further catastrophes, reinsurers will have to update their models, according to Guru Rao, the vice president and managing director of Aon Re Services. Since the behavior of catastrophes is beginning to change, models are tending to underestimate losses, at least on an individual company basis, Rao said.

New models will have to account for and analyze the new attributes that seem to be characterizing hurricanes. “In 2004, we saw something we hadn’t seen before and that was the clustering effect,” Rao said. “[That’s] where a number of catastrophes hit one small geographic area within a small, six-week amount of time. The issue that stemmed out of that, from a cat modeling perspective, was that it forced firms to update their models by focusing on the frequency that 2004 delivered.”

Rao added that the 2005 hurricane season also introduced new cat characteristics. “Not only did 2005 continue the frequency rate, but now there is a new focus on both frequency and severity,” he warned.

Rao warned the increase in storm activity might last 10 to 20 years. Additionally, he said, the insurance industry is not only being hit with more hurricanes, but also more “energetic” ones that could continue to result in greater damages. “The energy released by hurricanes has increased by more than 70% over the last 30 years,” Rao said. “Of this increase, 15% is due to increased wind speeds, and 60% is due to the storm’s lifetime; Katrina confirms that trend.”

“With Katrina it’s the overall impact on the economy that is driving the demand surge, at least 300,000 homes have been destroyed, building supplies had been destroyed and the labor force had been displaced.”

ECONOMIC ENVIRONMENT

Prior to the chaotic consequences of Katrina, the first half of 2005 showed financial promise, as well as minimal rate increases for the P&C market, according to Sean Mooney, chief economist for Guy Carpenter & Co. During the beginning of the year at least, the industry’s immediate future was off on the right foot: economic indicators pointing towards good numbers for the remainder of the year. Insurable claims incurred (pre-Katrina) had increased a mere 3.1%, Mooney said.

Unfortunately, a domino effect began as soon as Katrina entered the cat canvas. Mooney said Katrina initially caused claims to rise 34.4%. Then Hurricane Rita prompted another increase of about 4.7%. Finally, Hurricane Wilma added another 8% to the undesirable increase in claims.

Additional cat events, such as the 2005 tornadoes, tacked on another US$51.9 billion in losses. Mooney reiterated that the incremental figure reflects the worst historical year on record.

However, Mooney also pointed out that the losses were not as severe as some might have supposed. “It turns out that there will be less domestic loss than anticipated and that we will likely end up with positive underwriting numbers,” Mooney explained.

Mooney went on to predict an optimistic outlook for the insurance industry, and for reinsurance in particular. Most companies gained financially because of good investments, he said. The influx of at least US$5.5 billion in capital during 2005 projected a good primary market by year-end, according to Mooney. “Some areas may now be moving into a period of decline, but not all lines overall,” he said.

Primary or commercial insurance lines are expected to survive the Katrina epoch and tend towards a softening cycle, according to Mooney’s predictions. “As we get into next year, there typically won’t be that many catastrophes, so you’re not going to see the prices decline that much,” Mooney said. “Rates will stay where they are now, and capital areas will become higher. If you get lower losses, then you’ll have very strong underwriting numbers, and so 2006 should be quite strong.”

Mooney extended his prediction, declaring that the “strength” anticipated for 2006 would extend into 2007 and 2008. He clarified this statement, however, explaining that the years may get progressively “worse” because competitive forces will begin to move in.

CANADIAN MARKET REVIEW

While the Canadian marketplace has not “had quite as exciting a year” as the U.S. market, it has gone through “a tremendous amount of change over the past year,” according to president and CEO of Royal & SunAlliance Canada Group Rowan Saunders.

A comfortable, Cdn$30-billion business, with a ROE (over a 30-year period) of approximately 10%, reflects the competitive market that defines Canada’s insurance industry, according to Saunders. “Fairly recently, the top two carriers in Canada took control over about 20% of the business,” Saunders said. “The Top 10 typically control about 53% to 54% of business.”

Prior to this consolidation, Canada had been dawdling behind the growth momentum of other global markets, Saunders said. He claimed this was due to Canada’s historical difficulty with “organic growth.” However, with larger players and more capital entering the market over the past couple of years, Canada’s companies are at the brink of expansion through mergers and acquisitions. “From now on, we’ll see more changes as consolidation picks up,” Saunders predicted.

Even broker lines have made the move from “Mom and Pop” operations to larger-scale organizations, Saunders said. He pointed out that regional Canadian brokers are enjoying significant growth by concentrating their strategic business plans on mergers and acquisitions. “Now it’s quite common to see large Canadian brokers with Cdn$200 to $250 million in premium volume flowing through their businesses,” Saunders continued.

Over the past few years, Canada’s market has moved increas ingly toward consolidation at the broker and insurer level, leading to “some record earnings,” Saunders said. Reserves have been strengthened, he added, capital is building, and shareholders and the public market are working towards a continuation of this.

Overall, the distribution channel in Canada is changing. Saunders predicted this would continue at an increased pace, despite the almost certain entrance of the banks into P&C insurance retailing.