Rising or Falling Fortunes?

Canada’s reinsurance industry is flush with capital and, barring catastrophes, could sustain a soft market for up to five more years, a reinsurance intermediary told an October 2007 Canada Professional Liability Underwriter Society (PLUS) meeting in Toronto.

“I believe, personally, that the soft market has a long, long way to go down yet,” said Jonathan Beach of Beach & Associates Ltd. in Toronto. “The reason I say that is because there is so much capital still swishing around in the market. Rates are only a recognition of the amount of capacity or capital available to write business…

“Barring catastrophes, which of course are always difficult to predict, I believe we are in for another five years of a softening market.”

Tim McCoy of Signet Star Re in Greenwich Connecticut echoed that the Canadian reinsurance market is “in a remarkably healthy state at this particular juncture.” He noted Canadian reinsurers in 2006 posted an average combined ratio of just under 87% on Cdn$1.8 billion in premium. This was significantly different than the combined ratio of 119.1% that Canada’s Reinsurance Research Council members posted in 2001, during the hard market.

“That’s all really good news,” said McCoy. “If you turn back the clock, it’s only been five years since our balance sheets, our results and maybe in some cases our jobs, were definitely in jeopardy.”

GIVING BACK (THE WRONG WAY)

McCoy agreed with Beach that, as it stands now, the Canadian reinsurance industry’s current capital levels could sustain a soft market for between three and five more years.

But there is a negative side to the relative financial health of the Canadian reinsurance industry, the PLUS Canada panelists noted, and that is there is now pressure to lower reinsurance rates. “Reinsurers need to be careful, extremely careful, that they don’t sell their product at a lower price than is being absorbed [by the market],” Beach said.

Christopher Suarez of Odyssey Re in New York noted the reinsurance industry during the hard market of 2001-03 managed to secure rate increases on good accounts of between 20-50% in an effort to replenish its capital. “Over the last 24 months, we have given most of that back, if not all of that back [in the form of rate decreases],” he said.

What will stop a spiral back into the hard market of 2001-03?

Experience, for one thing, McCoy said. “I think a year ago, we considered ourselves to be in a robustly competitive market, and I think today we are looking at it realistically with both eyes open, looking at what cedent [insurance companies] are doing and what [kind of business] they are walking away from,” he said.

Demonstrating self-discipline in offering policy terms and conditions can help mitigate the financial effects of rate decreases, the panelists noted. For example, McCoy and Suarez both noted that during the hard market in 2001-03, reinsurers were locking themselves into multi-year policies with their client insurers.

Since then, one-year policies have become the order of the day. In fact, in the face of the rate deterioration seen over the past two years, Suarez said, “the only thing we are hanging onto is some of those conditions that were achieved, like one-year policies.”

Smaller policy limits are also a contemporary phenomenon, Beach observed. He noted the reinsurance industry during the previous soft market offered “much, much larger limits” to its clients. Anecdotally, policy limits of up to US$50 million were offered prior to the 2001-03 hard market, Beach said, although he believed this figure to be “an exaggeration.” Still, he added, policy limits now infrequently reach the level of US$25 million, and are more commonly offered at US$10 million or US$15 million.

Reinsurers should also take steps to avoid backstopping cedent insurance companies that do not practice what they preach in terms of price stability, McCoy noted. “We have to align ourselves with the cedent companies that are like-minded to our strategy, otherwise [rate discipline] doesn’t work,” he said.

The appearance of an extended soft market is also the product of a claims environment that has seen reduced frequency of directors’ and officers [D&O] claims in 2007. “How much of the rate erosion we are experiencing right now is being driven by what some would describe as a more benign claims environment?” panel moderator Darin Scanzano of Liberty International Underwriters in Toronto asked panelists. “Broker friends are quick to remind me that U.S. security filings are down and claims counts are down? Are we in a false state of mind in thinking a one-year blip in the filings of class action lawsuits south of the border [is a long-term phenomenon]?”

McCoy said reinsurers in the United States are “reviewing very closely” the apparent decrease in D&O claims, although it is not yet known what is causing the phenomenon. He said reinsurers must be careful with this, because the product is driven by large claims such as class action lawsuits. There could be a “lag time,” he suggested, in which large claims of years ago haven’t been fully processed in the legal system, and therefore the low claims frequency now could be deceptive.

“All it takes is a couple of bad settlements,” McCoy said. “For example, we may be looking at a big settlement number in 2012 and scratching our heads saying: ‘Wow, we still had a US$3-billion or US$10-billion settlement … but our frequency was at an all-time low.”