At the end of 2005 it was widely believed the ART sector would see renewed interest in response to the renewal rate hikes Ronald Gift Mullins explains why this isn't happening.
In years past, when rates for property/casualty reinsurance and insurance began edging upwards, heralding a hardening market, business intensified for the alternative risk transfer (ART) market. Considering that 2005 had the greatest catastrophe losses ever recorded by the P/C reinsurance and insurance industry, expectations were that rates would begin to climb as $50bn plus in claims and reserving began drawing down the surplus of insurers and reinsurers. This trend, it was anticipated, would result in a strong boost to the ART sector in 2006. Instead, this traditional inverse correlation seems to have been thrown out of kilter.
Holding back the ART tide
One factor that has stalled a shift towards the ART market is that widespread price increases for all reinsurance business have failed to materialise.
These keen increases had been predicted by chief executives of three of the world's biggest insurers and reinsurers, Munich Re, Swiss Re, and Hannover Re, at the Rendez-Vous de Septembre in Monte Carlo. Commenting on the January 2006 renewals, Charlie Cantlay, deputy chairman of Aon Re UK, said, "It is very much a market characterised by a great divide between business with US wind exposure and risks elsewhere." He said major rate rises have been limited to US property, marine & energy, and retrocession.
"The immediate impact of the hurricane season fell short of the market-changing event some expected," said Grahame Chilton, CEO of Benfield.
According to a report prepared by Benfield, property catastrophe treaties in the US experienced the greatest price increases, more than 100% in some cases. Loss-free property business in the US was up 10% to 20%, compared with price falls of up to 20% in January 2005. In Latin America and the Caribbean, Western Europe, Australia and Central and Eastern Europe there were swings from price decreases in 2005 to either flat or low double-digit growth.
Even with $50bn or more in catastrophe losses in 2005, the 5.2% increase in P/C surplus to $414.3bn at the end of nine months in 2005 from year-end 2004 signalled that there was a huge amount of capital available to underwrite risks, high and low, in 2006. This richness made insurers less eager to raise premium rates overall, taking away a major incentive to look at what the ART market has to offer.
Another factor retarding general price increases has been the $9bn in new capital which created 14 insurance and reinsurance companies in Bermuda as well as, spurred by the threat of downgrades from the rating agencies, the augmenting of surplus of existing re/insurers by $14.5bn, according to SNLFinancial. This more than $23bn in additional surplus required underwriters to put it to use, and they entered the market to take a quick look for sensible risks to write, at flat rates or with small increases for other than coastal property, energy and marine. Risk managers, fearing a hefty hike for insurance coverages, found instead underwriters offering policies not greatly changed from those early in 2005. The products offered by ART purveyors found their reception not as welcomed as had been forecast late last year.
A further unknown, but a possible potent force impeding the growth of the ART market may be the aggressive 2006 renewal strategy of several mammoth reinsurers. Instead of seeking sharp increases on all lines, they were selective with rate boosts with the intention of biting off a sizeable chunk of market share from Bermuda and captives domiciled in the US, from the London market and Lloyd's. "The balance sheets of the global reinsurers are very strong," said Robert Cubbin, CEO of Meadowbrook Insurance Group.
"Now, with Swiss Re absorbing GE Insurance Solutions, it is going to give the company a great deal more clout than it already has, which may be an indication that the reinsurer intends to hold the line and keep prices from dropping in non-cat areas."
Swiss Re and Munich Re have been sensible in their approach to treaty reinsurance renewals, said Stephen Cross, CEO of Aon Captive Services Group. "The increases have been sensible and lasered toward risks in high-risk conditions - windstorm, ice storms, earthquakes, hurricanes - so that the general hardening that was expected has not really occurred."
"What does this mean?" he continued. "Well, it's going to be very interesting to see what the new Bermuda companies will be doing this time next year.
What will they have done with their capital to produce returns for investors?
I think the big reinsurers wanted to pick up a greater share of the market by keeping rates from increasing a lot, and it kept the new players from cashing in on what their investors supposed would be a prime opportunity for making fat profits." However, he wondered what would happen as 2006 unfolds if hurricanes again cause billions of dollars worth of damage and prices climb. It may help the new Bermuda companies to prosper, he predicted, "They will be well poised to take advantage if there is a tight market in 2006."
The size of ART
Over the years, there have been thoughtful estimates of how large the ART sector is, compared with traditional re/insurance. In April 2005, AM Best said that by the end of the year, the ART market would have 50% of the US commercial market, compared with 40% in 2000, and close to 30% in 1996. A survey in 2003 by the Risk and Insurance Management Society (RIMS) found that only 40% of risk managers reported they used the ART sector.
According to a 2003 sigma study by Swiss Re the ART market in 2001 had a global volume of some $88bn, more than half of which flowed into US self-insurance programmes, and about 40% went to captives. The report suggested ART global revenue would grow 10% per year to 2005 which would put the figure at close to $125bn. Estimating the global P/C, health and accident insurance premiums for 2005 at close to $1 trillion, ART would represent about 12% of that total. Aon's Cross believes it is difficult to put a figure on how much premium is being taken by the ART market from the regular reinsurance and insurance companies. "I can't support any figure," he said.
ART any time
Though there have been modest rate increases generally for insurance buyers in 2006, there have been hefty jumps in rates for property, business interruption, and marine and energy coverages, especially those located in Gulf coast states. To soften these hikes in specific areas, insurers and companies may make greater use of ART, said Chuck Welsh, partner in the insurance/reinsurance department of Edwards Angell Palmer & Dodge.
"The range of products in the alternative market now has greatly expanded within the past decade. Today, ART encompasses business continuity plans, loss prevention programmes and loss control measures, several forms of captives, catastrophe bonds, securitisation, risk retention groups, higher self-retentions and deductibles, as well as employing sophisticated risk management tools which can more accurately determine how much risk the company can afford to take on and how much to insure or transfer to reinsurers."
"In 1955, when the Meadowbrook agency was formed, no one had ever heard of alternative risk management," Cubbin recalled. Early on, the company specialised in group association endorsed programmes for various lines of insurance including property and liability. "In the mid-1970s, most insurance companies were having great financial difficulties. In 1974 and 1975, they lost 30% of their surplus and cut out competitive programs, leaving our clients and us high and dry. That proved to us that we could not rely on insurance companies for long-term support. Therefore, we looked for ways for our clients and ourselves, to get out from under traditional insurance."
"At that point," he said, "we came upon the idea of the captive insurance company, which was a very new concept. In 1976, we put together our first captive in Bermuda, and we developed the themes on which we would create services and continue to be involved with such operations."
"We have a pretty robust pipeline with firms that want to form group or individual captives," Cubbin continued. "There is always interest.
When the market hardens and rates go up that interest is accelerated, and then companies tend to look at ART. When you are not an enormous company getting attention from reinsurers at the end of the year or in January," he said, "it is pretty tough." ART offers alternatives to reinsurance, and he advised that when the market is soft, that is the time to investigate what the ART market can do to lower costs. "Even if the market doesn't substantially harden," he added, "it is an opportunity to look at alternatives, even if there are only 3% - 5% rate increases."
He said the goal of any ART programme is reducing severity and frequency of losses. "Once people get into alternative risk," he added, "they expect and demand a better return-to-work and training programmes, which reduce costs."
"There are huge industries - chemical and oil, transportation, national retailers, real estate companies - that have assets sitting in hurricane prone territory," said Aon's Cross. "They insure into a captive, but they will lay off some of the risk to reinsurers. They will face increases in high-risk areas. Therefore, if they are not currently involved in some level of ART they will soon find a need to investigate it for those high-target areas."
While there was an intense push to form new captives in 2005, about the same as in 2004, Cross said, there has been less interest so far this year. Companies and insurers are now turning more towards using other aspects of the ART market. "Frankly, we are seeing a strong interest towards a holistic approach. Sarbanes-Oxley has required companies to comply with a host of requirements. Boards and executives now have to understand their uninsured risks and what losing them could mean to the operation of their company."
"We are doing more consulting-type processes to be sure companies are complying with regulations," he continued. "Also, we are looking at all kinds of issues that aren't normally considered within the ART configuration.
For example, when Katrina swept through the Gulf of Mexico, it took out a lot of the infrastructure that enormous companies depend on - transportation, supply chains, energy, electricity and even employees. The overwhelming destruction of Katrina opened a lot of peoples' eyes to the realisation that they need to look beyond their own facilities and plan how they will survive if there is such a wide-spread catastrophe like Katrina again."
Avoiding brokers and insurers
James Epstein, CEO of EWI, doesn't see any dramatic increase from the norm for the ART products or services, but said that the number of states that are seeking companies to form captives "has made it easier for industrial companies and commercial enterprises of a certain type to take advantage of alternative risk, by setting up captives to enable them to go directly into the reinsurance market. I think a lot of that is happening in spite of hurricane losses. These companies have decided it is easier to set up a captive in the US and avoid primary brokers and go directly to reinsurers. There are cost savings from not having brokers and consulting fees."
As chief risk officer for a number of companies within Contran, the ultimate parent of EMI, Epstein raised risk management focus on loss control and safety, and made greater use of captives for excessive coverages. "We took on more risk which we can now control ourselves. Looking at past years' risk management processes, we found we had lower deductibles than necessary and a lot of insurance that was repetitive or overlapping or unnecessary. We try to avoid using big brokers and primary insurers. Using captives, we can go to reinsurers and negotiate with them directly."
Chuck Welsh noted that companies can do some things themselves to keep their house in order and mentioned loss prevention and training programmes, higher self-retentions and deductibles. "But, you can only do so much of that, and in the end, they don't do a lot to protect assets," he said.
"When you are talking about catastrophic damages from a hurricane or earthquake." He suggested cat bonds as an alternative, "but these are getting pricier and if there is a loss, payment is not always swift. Securitisation can only be employed by the biggest companies because it is expensive and there are some regulatory concerns around setting up the instruments."
He observed that companies that set up their own captives and then lay off part of the risk to reinsurers have to deal directly with them when there is a loss to get what they are owed. "The reinsurance world has changed in the last ten or so years," Welsh said. "The capital market has made reinsurers look to higher returns on investment which has propelled them to grab harder for profits. This has made the relationship between insurers, including captives, and reinsurers more adversarial. You can see this change by how much the number of arbitrations between insurers and reinsurers has increased. Twenty years ago, the dollar value of a claim would have to be a million dollars or more before taking it to arbitration. Now, I see them as low as $300,000."
- Ronald Gift Mullins is an insurance journalist based in New York City.