Executives from the global reinsurance industry assemble each year in early September at Monte Carlo to discuss the industry’s state of health, an event that was first held in 1957. Over the years they have been joined by representatives from banks, rating agencies, law firms, brokers, intermediaries and risk modelling firms. More than 3,000 individuals met last week in the principality, where there is still scant evidence of the eurozone crisis that featured in many discussions.
Five years into the world economic downturn, both insurers and reinsurers can claim with some justification that their performance leaves that of the banking industry in the shade. Admittedly the once-mighty American International Group (AIG) was laid low in 2008 after dabbling in the toxic products that felled many of the banks and had to be rescued by the US government, and several other major re/insurers got their fingers burned around the same time.
However AIG’s state-backed rescue was the exception; overall the industry’s performance has been resilient and it has borne the hefty financial impact of several major natural catastrophes. In 2011 loss payments for disasters ranging from Japan’s earthquake and tsunami to floods in Australia and Thailand resulted in insured losses of more than US$100bn, yet no corporate casualties resulted. This resilience, coupled with the prospect of premium rate increases, has stimulated investors’ interest. Aon Benfield recently reported that the reinsurance industry had total capital of US$480bn at its disposal midway through 2012, a 5% increase on the figure at the end of 2011.
The conference regularly coincides with some particularly costly event. In 2001 it ended prematurely following the 9/11 terrorist attacks, discussions were dominated in 2005 by losses caused by hurricane Katrina and in 2008 by hurricane Ike. The chain of floods, earthquakes and storms in 2011 saw losses extend beyond property damage to business interruption from disrupted global supply chains, as essential components from Japanese and Thai manufacturers became unavailable.
Over the past 20 years several costly natural catastrophe (nat cat) losses, from hurricane Andrew in 1992 onwards, have removed massive amounts of capital from the market. Increasingly it has been quickly replaced. After the 9/11 losses, and four years later in the wake of Katrina, new companies formed in locations such as Bermuda to take advantage of higher premium rates. Indeed, the reinsurance industry’s ability to attract fresh capital means that the capacity it can offer frequently exceeds actual demand – as is currently the case.
After several years of declining premium rates, significantly higher prices were expected for many lines of business following the nat cat losses of 2010-11. In the event, plentiful capacity meant that generally the increases were relatively modest and already this firmer trend appears to be faltering. While this year’s scorched harvests and low yields in the US will cost some primary insurers dearly, reinsurers have felt little financial impact and 2012 has otherwise proved relatively loss-free – as evidenced by the industry’s nat cat losses of US$12bn for H112 compared with US$81.7bn for H111.
Ratings agency Fitch last year commented that it would take a catastrophic single event (on the scale of the World Trade Center loss or Katrina) costing the industry at least US$50bn to push premiums higher. This year, in a release issued to coincide with this month’s Monte Carlo gathering, it revised that minimum figure to US$60bn. “A further catastrophic loss coupled with an inability for reinsurers to replenish lost capital is the most likely threat to the sector’s stable outlook at this time,” said Martyn Street, director in Fitch’s Europe, Middle East and Africa (EMEA) rating group. “Historically, this has been a rare combination.”
Focusing on Figures
As a result, reinsurance executives at this year’s Rendez-vous were less preoccupied with hurricanes, floods and quakes. Instead, they focused on the future of the eurozone, coping with a prolonged low-interest rate environment and their industry’s place in the business world. There were some positive developments to celebrate. In 2005 much of the new capital that moved into the market to replenish that paid out in losses from hurricanes Katrina, Rita and Wilma (KRW) was largely short term. Once the sharp spike in premium rates that followed KRW began easing off, much of this new capital departed and the onset of the financial crisis in 2007 extended the process.
But more recently the meagre returns from government bonds have encouraged life companies and pension funds to also become capital providers to the industry, often in the form of insurance-linked securities (ILS) such as catastrophe bonds (cat bonds). Aon Benfield reported that several new companies backed by hedge funds have entered the market in recent months. ILS issuance in 2012 has surpassed US$4bn and is on course to reach US$6bn by year-end, a total that would exceed the previous record set in 2007. There is every expectation that these new investors will stick around for rather longer.
Despite these positive developments the mood was downbeat this year in Monte Carlo, where the main topic for debate was the reinsurance industry’s capital management skills. General consensus was that companies could be doing a better job, as well as promoting the industry’s cause to regulators more actively. “The regulatory environment remains in flux and continues to be shaped by banking issues,” noted Richard Ward, chief executive officer (CEO) of the 324-year old insurance market Lloyd’s of London, who was part of an industry panel at the keynote event. “Yet (re)insurance has a very different business model from banking.
“There are many still-unconcluded regulatory debates such as Solvency II, ComFrame [Common Framework for the Supervision of Internationally Active Insurance Groups – currently in development by the International Association of Insurance Supervisors (IAS)], Global Systematically Important Institutions (GSIIs) and statutory collateral requirements – all of which carry a real risk of higher regulatory, compliance and capital costs.
“Regulation isn’t going to go away. It will only increase so we must continue to actively engage in debates.”
Mike McGavick, CEO of XL Group, had other criticisms of his industry. “The market says that we are not good stewards of capital,” he said. “Our sector trades at below book value due to a belief that, over time, we’ll destroy value. Our share of [primary] property and casualty insurance business is declining and we can either address this or face the prospect of making less and less difference to the economy.”
McGavick offered a few facts and figures to underline the industry’s “decline in relevance”. Over the period 2002 to 2011 global growth in gross domestic product (GDP) averaged 3.8%. While the insurance industry had also grown over the same period, from US$1.1 trillion to US$2 trillion, this worked out at annual growth of only 2.5%. “To look at it another way, the industry’s contribution to global economic activity has fallen to 2.8% from 3.4%,” he adds.
Slow to Respond
The decline was evidenced by insurers’ and reinsurers’ reduced involvement in two of the world’s most dynamic industries, technology and power. The world’s top five companies: Apple, MobilExxon, Microsoft, ChinaPetrol and IBM, each enjoyed an individual valuation that far exceeded that of the entire reinsurance sector.
The technology industry was increasingly focused on the instant sharing of data, as evidenced by the 1.15 billion smartphones in use globally in 2010 – a figure set to increase to 4.3 billion by 2020. “Watches, cameras, video cameras and conventional phones will all become obsolete and their industries, which we insured or reinsured, will no longer exist,” says McGavick. Insurers and reinsurers had tentatively developed new products such as cyber liability policies in response, but 72% of tech companies have yet to buy the cover.
Similarly, many power and energy companies had decided to insure the vast infrastructure projects that are a feature of the industry from their own resources. When BP suffered the Deepwater Horizon spill in 2010, the involvement of insurers and reinsurers was minimal as it was revealed that the company self-insured.
McGavick also suggested that insurers and reinsurers had been slow in recognising the development in the business world of just-in-time supply chains. Although these have existed for more than two decades, they appeared to be astonished when last year’s Kobe earthquake and floods in Thailand exposed the resulting interdependencies. Too often the industry’s response had been to impose exclusions or sub-limits onto the cover provided, which only served to make its products and services less relevant to corporate clients.
Underwriters also habitually demanded 10 years of data from their business insureds when assessing a risk “but whole industries will come and go while we wait for this data,”McGavick suggests. This could only be addressed by the industry starting to make better use of analytics and recognising that its best talent could not always be assigned to the most profitable business.
“As we work towards this end, Solvency II will come to life, demanding even more capital and driving our industry to produce lower returns, more M&A [merger and acquisition] activity and fewer companies,” he concludes. “The alternatives are to hunker down, play safe and accept this fate, or to struggle to reclaim relevance to our corporate clients.”
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