Central European markets have been an adventure playground for reinsurers, but they have proved cruel, sending reinsurers back to basics. Adrian Leonard investigates.
In one short decade, our image of Europe has been extended east and south to incorporate the countries of the former Soviet Union. Western reinsurers have always done business with the great state monopolies that dominated Soviet insurance, but today countries including the Czech Republic, Poland and mother Russia herself offer new markets, new cedants and new premium. However, in a year of turmoil for the international reinsurance sector, the markets of central and eastern Europe have not been particularly calm waters.
In the decade since the iron curtain fell, the territory has been well trodden by reinsurers, particularly from Europe. However, as elsewhere in Europe, the talk at the current renewal is of capacity shortages due to withdrawals from the sector. The run-off of Gerling Global Re's property/casualty (p/c) reinsurance business provides the biggest shock. In a region yielding total reinsurance premium of about $2bn (of which about 90% is treaty), Gerling was on almost every treaty, writing an estimated 5% to 7.5% of all the business in the region. Last year, Cologne Re scaled back significantly, particularly in Poland, and stopped writing proportional facultative covers. Elsewhere, senior managers have seen huge flood losses flow in under Czech treaties, and as a knee-jerk reaction some have withdrawn capacity from the entire region.
Meanwhile, some new capital has entered the fray, primarily from start-up reinsurers. Their main focus has been catastrophe programmes, and the effect has been predictable: to hold down anticipated price improvements for natural catastrophe perils (which this year reinsurers are attempting to exclude from pro rata treaties). With the exception of flood risk generally, which is expected to become massively more expensive, and Czech catastrophe specifically, where deductibles may increase by 50% or more, some reinsurers may find their expectations for natural catastrophe rates are not met - although generally prices for catastrophe excess of loss treaties were hiked to sustainable levels during the 2002 renewal.
Nonetheless, the general environment in the region is one of a reinsurance capacity shortage, with reinsurers in the driving seat, and rates are shooting up. By 1 December, only a handful of programmes had been structured and shopped around the market. A late renewal is expected, as reinsurers go back to basics, reassess probable maximum loss (PMLs), and force clients to reconsider the value of big pro rata arrangements. If they extract the catastrophe cover from proportional treaties and price natural perils individually, or if only limited natural catastrophe cover is granted through the introduction of an event limit, many cedants will want seriously to consider spending more on excess of loss cover, and question the value of big quota share programmes. Thus insurers and their brokers are busy structuring programmes for the new environment.
Either way, many insurers are likely to be unable to find the capacity they desire, and those that had hoped to triple their reinsurance support are certain to be disappointed. Some Russian insurers, for example, had been approaching reinsurers in Monte Carlo seeking $250m in cover, had reduced their expectations to $200m by Baden Baden, and are now ready to be satisfied with $150m or less.
In the meantime, the quality of local underwriting is mixed. Most of the major insurers are appointing surveyors and risk managers as a matter of course for large industrial risks, but much of the growing local reinsurance market involves simply swapping retentions and writing first loss policies - practices which tend to go straight to the bottom line of foreign reinsurers. Little quality facultative excess business is written, but raw capacity continues to fuel the market. Foreign reinsurers are dismayed at the amount of marine business that finds its way into treaties, although rates for energy business are increasing, and marine hull prices and deductibles are also going up.
One big factor in the Russian market in the coming year will be the advent of a law making motor third party liability cover compulsory. The line is expected to generate new premium of about $1bn, which is bound to test the capital adequacy of the Russian insurance market. With global reinsurance capacity already stretched, western reinsurers are unlikely to be looking first at writing motor quota share business in an untested and notoriously challenging market, except at punishing terms (and after commissions under quota share treaties were generally reduced at the 2002 renewal).
Thus it could be very difficult for insurers to find the reinsurance capacity they need to make a big splash in Russia's new line. One outcome could be that some Russian companies choose to reallocate capital to motor underwriting from the insidious quasi-insurance salary-scheme contracts which dominate Russian premium income (and whose sole purpose is to evade payroll taxes). Controlled tariffs for motor premiums have been set much higher than expectations, and should be sufficient to generate profits. Meanwhile, increased limits for compulsory motor limits in Poland could also drive increased purchases of excess of loss cover, which, however, may be difficult to find.
One important realisation is driving change in underwriting behaviour: following the calamitous August floods in the Czech Republic (which cost reinsurers about $950m, or 95% of the insured loss), the region's catastrophe exposure is becoming more widely recognised. The awareness has come late: notwithstanding losses that washed up with the Czech floods of 1997 (about $300m for reinsurers), underwriters ought to have remembered hail and hurricanes in the centre of Moscow, floods in southern Russia this year, earthquakes in various regions, and the other miscellaneous catastrophes that do hit the region. It may be that before now, brokers had been doing their job too well, but the exposure certainly has top-of-mind awareness now, as reinsurers will spend at least as much on the current Czech flood claim as has been ceded from the country since liberalisation.
As if the flood wasn't enough, the Spolchemie chemical plant in Usti nad Labem, Bohemia, was destroyed by fire on 22 November. At $75m, it could be the largest Czech fire loss in history. It is insured in the local coinsurance market by the insurers Ceska Pojistovna, Kooperativa and IPB. As much as 90% of the loss is expected to fall to international reinsurers, highlighting their calls to reduce coinsurance. Munich Re is leading that charge, and is said to have widely introduced a clause across the region that limits cover for accepted coinsurance: if a reinsured accepts, say, 25% of a risk on a coinsured basis, the reinsurance protects only 25% of the accepted risk. In other words, local insurers are being required to retain a lot more of the risk they swap between themselves, which is certain to reduce local coinsurance and facultative business.
Such losses are concentrating the minds of reinsurers active in the region. Many feel the time has come to identify the industrial property insurers with the ability and wherewithal to be the leaders in their local markets, with a particular focus on the way cedants price their risks. In many cases they have done so poorly, such that major risks have been badly underpriced, based on hopeless PMLs. The combined effect of focussing on preferred insurers and restricted capacity (despite increasing prices) is likely to be a concentration of reinsurance support among a handful of quality cedants. That in turn could spur a concentration of local markets which, in the main, are hopelessly oversupplied by insurers.
New wave of investment
As reinsurers scramble, local insurance markets - particularly in central Europe - are becoming increasingly populated by foreign insurers. In 2002 a new wave of investment sent more local companies into the hands of non-locals, with a few high-profile investors doing much of the buying. One of these is the Dutch bancassurance group KBC, which has stormed into central Europe, and now controls or holds a significant share in insurers in Hungary, Czech Republic, Poland and Slovakia.
Early in the year, it acquired 65% of the Czech insurer IPB through its Czech bank, CSOB, and has since bought the remaining equity. A merger of IPB and CSOB's insurance subsidiary is anticipated soon, which would create the third largest insurer in the Czech Republic, with written premium exceeding Kc7bn. Later in the year KBC bought 65% of top-ten Slovak insurer Ergo (which is unrelated to the Munich-based group). Ergo had been the only top ten insurer in Slovakia without the support of a foreign partner. Bancassurance distribution is on the cards.
In May, KBC bought 34% of the largest bank in Slovenia, and has bid for a controlling share. It intends to sell life insurance products through the bank. Its largest regional insurance holding, however, is its share in Poland's number two insurer, Warta. With Warta's bancassurance partner Kredyt Bank, of which KBC owns 76%, the group is looking to launch a bancassurance operation in neighbouring Lithuania.
Another big buyer has been Austria's Wiener Städtische, which has been particularly acquisitive in the second half of 2002. During the period it has bought 90% of the Bulgarian life and non-life insurers Bulgarski Imoti; through subsidiary insurer Unita it purchased 53.6% of Romanian crop insurer Agras (from insurer Omniasig, in turn owned by TBI Holdings, an Israeli vehicle that invests in central European insurers); and it picked up 67% of life insurer Kontinuita-Slovenska in Slovakia, where it already controls the insurers Kooperativa and Komunalna, ranked third and sixth respectively. Wiener Städtische also owns insurers in Czech Republic, Hungary, Croatia, and, with HUK-Coburg of Germany, several in Poland.
Also in recent months, Viennese banking and insurance group Uniqa has fulfilled a long-held ambition to obtain an insurer in Hungary. It bought funeral expenses insurer Agrupacion Funeuropa, which it intends to use as a platform for life insurance business. It, too, has insurance subsidiaries across central Europe, and has recently been a bidder in the privatisation of Balkan insurers, including Croatia insurance and Sarajevo Insurance.
The biggest prize of all, however, is the acquisition this year by Allianz of Slovenska, the market-leading insurer in Slovakia, with 42% of non-life business and 29% of the life market. The local Allianz operation already has 18% of the non-life market and nearly 5% of life business, so the German market leader will have an unassailable share in Slovakia. Allianz has local insurers across the former Soviet bloc, from Russia to Croatia (and including the former East German monopoly).
Also noteworthy this year was a sale between big western insurers. Cash-strapped Zurich Financial Services surprised markets in April by selling the bulk of its portfolio of central European companies to rival Generali. Insurers from Poland, Slovakia, Poland and the Czech Republic changed hands in the deal, most of which are set to be merged with Generali's local operations.
While Scandinavians have purchased the bulk of the Baltic insurance market and only a fraction of the Hungarian market is owned by Hungarians, several strong local insurers remain in local hands, notably in Russia, Czech Republic, Poland and Slovenia. However, more change is likely: as the Poles fight valiantly to retain national control of PZU, the private ownership of Slovenia's Triglav is being disputed by the government, which hopes to sell the insurer.
For reinsurers, the sale of the majority of the insurers of the region to Western investors is a mixed blessing. Standards of underwriting are generally improved following such sales, but cessions - particularly when the buyer is a large entity such as Allianz or KBC - are expected ultimately, if not immediately, to decline. For a region that generates only about 1.5% of the world's reinsurance premium and just 0.94% of total primary premium, any subtractions are a negative event, especially as losses rise.
Yet reinsurers and insurers continue to be attracted to the region. For the latter, the reasons are clear: growing affluence, increasing insurance penetration, new product lines, and long-term growth potential. For the reinsurers, however, the motivation for venturing into central and eastern Europe is less clear. Because the region has so many insurers, it may appear that a lot of business is being done, despite tiny premium volumes. But that means a great amount of local knowledge is necessary to get the business right - it is a region for specialists only. Likewise many local insurers must seem like great cedants, sometimes handing over more than half of their premium. Yet losses like the ones experienced in Czech Republic this year must colour such assumptions. So it is back to basics for reinsurers active in central and eastern Europe - and not a moment too soon.
By Adrian Leonard
Adrian Leonard is a freelance insurance journalist and a regular contributor to Global Reinsurance.