Katrina will have a lasting and dramatic effect on the industry and the way reinsurance is purchased, say Ron Whyte and Julian Samengo-Turner
At the Rendez-Vous in Monte Carlo this year people were cautious. Precise details remain unknown as to the overall impact of Katrina, but one thing is certain: the hurricane will dramatically impact the reinsurance industry. It is too soon to say exactly how this will manifest itself. We don't even know the human death toll so, how can professionals start working out the personal and economic loss and then the insured loss? No one is sure how long it will take to work that out, as it is an incredibly complicated process with all sorts of issues and calculations for different companies and individuals.
The business interruption element will be particularly complex and will take time to unravel. There is also the question: was it one event or two? Or even three or four? There was wind damage but also the storm surge, the failed levees and the floods. There will be some fascinating legal discussions ahead. Meanwhile, there is an immediate requirement for reinsurance. Cedants are looking for backups and reinstatements, and this doesn't have to be exclusively in the treaty market. Facultative reinsurance could offer the solutions that people need.
Reversing the softening
There is often concern that, following an event as big as Katrina, capacity will move away from the fac market. But the market is unlikely to go "rock hard," and will instead slow, and in some cases reverse the current softening trend. Where there are increases, they will be more like 20% to 40%, not 300% as we saw in some instances in 2001. The perception after 9/11 was that there was gouging, but that is not anticipated again. It will be interesting to see the outcome, but there has never been a single event which has turned the market around 180 degrees from soft to hard "overnight". For example, in 2001 the market was already hardening before the terrible events of 9/11 and the disaster served to simply add impetus to an already upward trend.
The present situation is different to that which existed after Hurricane Andrew or September 11. There is plenty of capital in the market, so there will not be the same need for start-ups, and this capital is likely to go to the more established players rather than to risky start-ups. For this reason the changes will be significant but not calamitous. If there is another event this year - and remember there is still time in the hurricane season - and the market goes "rock hard", we would see rates change dramatically, and that could lead to a loss of some facultative capacity.
In general, fac should still benefit from emerging market conditions. The scope of facultative reinsurance is extremely broad, ranging from distressed and opportunistic purchasing, through strategic purchasing (to complement treaty) to what is essentially direct business behind a captive insurance or local insurance company. Virtually all business that comes out of Asia, Latin America or the Middle East is fac. Taking all the above into account, a significant percentage of the world's business is technically fac, so there is plenty of opportunity in the sector.
Traditionally, when there is a scarcity of capacity, insurers and reinsurers ask, "why are we writing fac when we could be more visible to the original client?" If there is a capacity crunch it would therefore be logical for fac capacity to move further up the chain. Post Katrina there will be significant changes in how treaty reinsurers structure programmes. This will lead to increased retentions in many lines of business and some restrictions of coverage in key areas. It is therefore an opportunity to eke out complimentary solutions in the fac market - protecting retentions or producing coverage top-ups for example.
Others have spotted the potential. While in Monte Carlo, some very high profile reinsurance markets revealed they have changed their attitudes toward fac. As rates softened over the last few years, we did less and less fac business with these markets. But just last month there was enormous interest in what is obviously felt to be a potential growth area. Many major Fortune 1000 companies were hit by losses from Katrina, and they are going to want superior claims services administration. In other words, they are going to be service-orientated rather than price-orientated.
The Spitzer legacy
The New York Attorney General, Eliot Spitzer, threw the insurance world into turmoil last October. Prior to that there was an imbalance in the industry between income earned on a fee basis from clients and the much greater revenues earned from commissions on the placement end. In effect, placement earnings were subsidising low client fees. Greater transparency led to the sacrifice of placement earnings, which cannot, in the short term, readily be made up by increased fees from clients. This clearly puts huge pressure on the larger retail brokers.
In addition, some smaller brokers had been looking to take business from the big three because of the allegations by Eliot Spitzer into brokers and their practices. At the same time some clients have been thinking that it may be time for a change, particularly with a generally softening market. Now, however, the major clients will re-evaluate what retail services really mean to them. Those that were thinking of changing will think again and will want to ensure they are with established, proven partners.
Katrina has brought insurance back into the boardroom, and made it top of the agenda for many companies. There are companies looking at their risk managers and asking if they have adequate cover, if they are exposed and if they have a broker who can sort out the administration and get the bills paid. In this environment, companies will place a premium on the service they expect from their brokers, rather than focus just on price. Would you move your business if you had Katrina as a backdrop and billions of dollars of claims? Most would stay put. Companies will pay their fees and again see the broker as offering a much-valued service.
There remains an opportunity though for the pure transactional broker. The fac business is robust in any market: when rates are low, people buy more fac because more is available. Should the market harden, people will buy less, but higher levels of it. So it balances out. Katrina is a huge loss. Many businesses can't survive without insurance, particularly now. And insurers can't survive without reinsurance. Get it wrong and you could be in trouble.