Getting back to basics and building on relationships is key for reinsurance companies seeking to navigate their way through the current market turmoil, writes Mairi Mallon
With the perfect storm of falling equities prices, a soft market and larger than expected losses from the 2008 hurricane season, the future of some of the industry’s traditionally most solid names is uncertain.
But how to survive in these turbulent times? An overall message has come through clearly: stick to your knitting, keep control of your costs, maintain underwriting discipline – and wait for prices to rise.
The consensus is that the financial crisis will get worse before it gets better, and, if you don’t put in place better risk management soon you could be in for trouble.
Rolf Tolle, the franchise performance director at Lloyd’s, believes that prices could go up in the first quarter of 2009 because of the combination of heavy claims from Hurricanes Gustav and Ike, and the hit on companies’ assets from the global financial crisis.
“The financial crisis will definitely help us to change the market,” he told about 250 delegates at the AM Best Insurance Conference in London. “But I’m not sure if a combination of these things is a market-changing event or whether it is something that just inflicts a lot of pain.”
In the past he’s said that the market could either flatten or go down further in the first quarter, with possible hardening in the second quarter of next year, but at the AM Best conference he said he’s now not sure which direction it will take.
A reversal in pricing would also be down to maintaining underwriting discipline, which was the last ingredient needed to make all this year’s events become market-changing “That means people have to say ‘I’m prepared to non-renew’. Then it will happen.”
John Andre, AM Best’s group vice president, also describes the current financial crisis, as “a market changing event”, saying it “may be big enough to affect underwriting conditions”. But he is cautious as to what those effects might be, saying that so far the world’s insurers and reinsurers have not felt a significant impact. “Overall, terms and conditions remain attractive. We’ve had relatively disciplined renewals to date, but there’s clearly pressure on prices.”
Richard Brindle, CEO of Lancashire, says he saw falling markets looming almost a year ago. “I don’t want to sound all smug here, but I said publicly in October last year that the next Katrina had already happened. I didn’t mean a single event, but a confluence of events – a softening market with the likelihood that we would see both attrition and catastrophe activity this year, plus there was going to be massive impairment to the asset side of the balance sheet.
“And that was long before American International Group (AIG)’s troubles had to be factored into the picture. Nothing has happened to change my mind.
We sold all our non-agency structured products last October, we sold all our Lehman’s bonds in February. We never had a material exposure to AIG, we are really underweight in equities. I remember saying at our board meetings this year that the equity markets were defying gravity because everything else was falling off a cliff.”
No one doubts the severe impact on investment returns, with billions of dollars wiped off the value of firms’ equity and bond portfolios. More risk averse companies have fared better, but across-theboard earnings have been affected, all of which will have a knock-on effect for the industry.
Andrew Barlie, an independent consultant for the (re)insurance industry, says there may now be many opportunities, particularly for Bermudian companies looking to pick up parts of AIG.
“But the most important thing is going back to basics and fundamentals. Buyers of reinsurance are doing their homework again. And there is a need for more independent directors who are experienced in reinsurance.”
A major factor in reversing the current pricing trend may be Hurricane Ike, which drove through the oil rigs of the Gulf of Mexico and hit Galveston, Texas. As we went to press, Ike was turning out to be a bigger claim than the models and industry predicted, with Tolle saying that the insurance bill could reach as much as $18 billion (€13.28 billion). Ike’s path was much wider than previous Category 2 storms, creating damage more like a Category 4 hurricane. “That will drive a lot of claims.”
While Tolle is satisfied that Lloyd’s underwriters have taken note of the prevailing market conditions and plan to trim their premium income projections for 2009, he hopes that the market will turn so that the company can take advantage of the changing conditions.
“I do not think continuous growth is something that we should ever endeavour to do. But we will grow in leaps and bounds when the time is right. But we will also shrink back when the time is wrong. At Lloyd’s, we are well-prepared to take advantage should those conditions come.”
Stronger corporate governance better prepared Lloyd’s, and he points to more stringent oversight and influences from capital providers, rating agencies, investment analysis, non-executive directors and regulators as all having a part to play in keeping the company on its toes.
But not everyone is as sure as Tolle of the impact of the current turmoil.
“I really don’t know what to add as ‘words of wisdom’ in the face of such unprecedented global financial crisis,” says Yassir Albaharna, Arig chief executive officer, from his offices in Bahrain. “It is really like a ‘black swan’ [referring to the book by Nassim Nicholas Taleb The Black Swan: The Impact of the Highly Improbable in which the author draws a map of what we don’t understand]. Surviving the current crisis is on every CEO’s mind today, yet events are still unfolding and no one could really assess what the final outcome will be. Putting up a defensive strategy appears, therefore, to be futile in such turbulent times.”
Analysis of reserves, of solvency capital, as well as risks and loss ratios, should be carefully monitored.
More companies are placing greater emphasis on perfecting their internal capital models. With the Solvency II regulations looming, most are hoping that their own models will be acceptable to regulatory authorities as falling within the ambit of the new risk-based regulations.
Edward Easop, AM Best’s vice president, rating criteria and relations, reinforces the “back to basics approach” to risk management. In describing Best’s Capital Adequacy Ratio, or BCAR, and the role of Internal Capital Models (ICMs) he stresses the need for both to evolve as times change. “Your need solid guidelines and you need to re-examine them on an ongoing basis.”
Mairi Mallon is a freelance journalist.
TOP TEN TIPS to help you survive the credit crunch
1 People still need to buy reinsurance, and they will buy it from companies they know and trust. Donâ€™t forget the importance of relationships and face-to-face contact. Persuade customers to spend money with you rather than the next broker or reinsurer. And go back to what you know best â€“ selling insurance and reinsurance.
2 The costly Hurricane Ike and some pricey acquisitions over the past year mean that the ratings agenciesâ€™ capital requirements could be easy to miss â€“ and if you get that wrong youâ€™ll go out of business. Monitor your analysis of reserves and solvency capital, as well as risks and loss ratios. Perfect your internal capital models.
3 Keep hold of your cash and sit it out. Shareholders and your board will not thank you if you play the market â€“ and lose.
4 If you are flush with capital, it could be the perfect time to snap up some chunks of companies such as AIG or XL Capital â€“ or buy up a rival. You could get a bargain.
5 If your share price is down, and you have the cash, why not buy back stock? But remember â€“ the volatile market means that such a move could send your stock price down further.
6 You know your rivalsâ€™ business nearly as well as your own. It might be time to buy some of their shares. But watch out. If you buy at what turns out to be the bottom of the market and the price rallies, you will be hailed a hero. If it keeps going down, you may find yourself out of a job.
7 Stop some of the more frivolous spending â€“ shareholders may not appreciate money being spent on champagne or tennis tournaments in Bermuda when their stock price is so depleted.
8 Then again, this could be the perfect time to do a marketing blitz or hold a client event. It will certainly stand out from the crowd and your money will go further with keen negotiation on prices.
9 The credit crunch, combined with catastrophic events and disciplined underwriting, could turn reinsurance prices sooner than expected. So if you can wait and make it past the falling share price and squeaky capital figures, 2009 could be a very good year. But only if underwriting discipline in maintained across the market.
10 Independent directors who know about reinsurance can give extra-special direction and perspective during all kinds of markets and can help find creative solutions.