Timothy K Pitcher looks at some of the challenges faced by the US property facultative market
With a gross domestic product of more than $9.5trn and a gross personal investment of more than $1.5trn, the US is the world's largest economic market. The US economy has also recently shown a propensity toward consistent growth at an average of approximately 3.5% (see Figure 1) and remains one of the strongest economies in the world.
The complexity, size and modern exposures associated with the US insurance market are a substantial challenge to facultative property insurers and reinsurers. Nevertheless, the North American insurance market represents roughly half of the global market from both a primary and reinsurance perspective (see Figures 2 and 3). Property makes up roughly one-third of that reinsurance market.
The US insurance market poses a unique challenge because insurance is regulated at state level. To gain regulatory and licensing approval requires negotiation and compliance with all 50 states. Each state has its own regulations and often there is little coordination between state agencies.
These obstacles help explain why most of the new capacity entering this market comes in the form of reinsurance.
As a reinsurer, most of the compliance and resulting administration can be mitigated because reinsurance markets are not as heavily regulated as primary markets. However, this approach can at times create disparities in coverage when primary markets are regulated to provide coverage or terms that are not supported by the facultative markets. Terrorism is the most recent example. Primary markets are required to provide this product in accordance with the Terrorism Risk Insurance Act of 2002 (TRIA), whereas facultative markets are not. Most facultative markets are restricting their support for terrorism coverage. These restrictions include TRIA, non-TRIA and fire following perils. This non-concurrency in terms makes it difficult for primary markets to balance their capacity needs with the risk of coverage gaps created by the use of non-concurrent reinsurance support.
Legal risks are another adverse factor in the US insurance market. The 'deep pockets' mentality has created an environment that strongly favours the insured. Intent does not always have to be clearly determined in a legal proceeding against an insurer. The plaintiff only has to prove that the intent is, at the very least, ambiguous in order to be successful.
In addition, the increasing tendency toward large insurance settlements - mainly driven by punitive damages - has made claims difficult to anticipate.
Neighbouring markets, such as Canada, are having a difficult time adjusting as their legal systems slowly take on the characteristics of their litigious neighbour, making it difficult for actuaries to use historical data in their incurred but not reported (IBNR) calculations.
With regard to property facultative insurance, there is another factor traditionally unique to the US market that is becoming more common on a global scale; the layered approach to larger insurance programs. Whereas European and Asian markets have a long traditional quota share history, layered programs heavily dominate the US market.
The scarcity of quota share property facultative reinsurance capacity in the US market creates cultural and strategic obstacles for reinsurers that do not have extensive experience with layered programs. This new capacity and lack of adequate portfolio management have affected the traditional insurance cycle by extending the soft industrial insurance market for several years of unprofitable performance. This market has become extremely unforgiving to reinsurers ill-prepared for the complex loss potential.
Size and modern exposures
Today's multinational clients have billions of dollars worth of assets and revenue streams protected by insurance programs. The mere economies of scale, combined with the modern risks associated with technology-driven processes that are commonplace in most large property risks, have made risk quantification very difficult. The latest strategic developments in the market economy, ranging from a just-in-time philosophy to streamlined consolidation, have meant that a shortage in cover and/or risk accumulation for the property and casualty industry can occur.
In addition, more mature markets, such as the North American market, have evolved into more service-driven economies as opposed to manufacturing-based economies. The resulting geographical consolidation to such business centres as New York, Boston, Chicago, San Francisco, Toronto and so forth has produced additional accumulation considerations which are complicated even further by increased climatic events that are arguably magnified by the effects of global warming. In addition, terrorism has recently shown how vulnerable the insurance industry currently is to a very localised and concentrated event. The loss of the World Trade Center (16 acres) has produced the largest insured loss in history. Urban areas throughout the US and in other mature economies around the world have a growing exposure density.