Japan's islands, constantly threatened by earthquake and typhoon, comprise one of the most economically developed catastrophe-prone areas of the world. Since they also represent the world's second-largest insurance market, many reinsurers are keenly interested in ensuring that their Japanese exposure is both correctly priced and adequately measured. Others see Japan's hunger for catastrophe capacity as an opportunity to bolster the top line. Either way, achieving the right price for the right cover has not been a common accomplishment recently.
Progress is creeping forward. April renewals delivered positive price movements, and highlighted reinsurers' increasing resolve. Yet reinsurers agree that ratings remain inadequate, and that the typical programme structure is unsatisfactory and needs further reform. One cat specialist described windstorm programmes as “underpriced by 300%”. In consequence, many larger reinsurers have been beating a retreat from Japanese catastrophe exposure.
Treaties – particularly proportional treaties – were difficult to finish at the 1 April renewal, and many were not completed until weeks afterwards. Reinsurers, complaining of increasing aggregates, slashed shares. One proportional treaty, for example, went from 90% to 67%. When reinsurers wanted to maintain their support of certain treaties, significantly increasing aggregates sometimes meant they had to cut back. Any expectation that cedants will pay back major losses over the successive 99 years is now gone. The upshot is that many reinsurers are demanding increased transparency and new approaches to the management of Japanese cat exposure.
Charge for change
Swiss Re led the charge for change, informing its clients mid-way through last year of its intention to convert as much of its Japanese catastrophe exposure as possible from proportional to excess of loss treaties (Global Re Vol 9 Issue 8, Asia's Muted Rebound). “The demand to shift is the result of reinsurers' feeling that, because of the liberalisation, original rates are falling as exposure increases,” said Takashi Oka, director and general manager of Tokio Marine (UK). “More policies are written on a first-loss basis, so original prices should be higher. There is more transparency in excess of loss than in proportional, so reinsurers want to switch. It is a continuing process.”
Diethard Kaiserseder, a Swiss Re client manager for Japan, said: “We achieved our goals to some extent regarding a shift of capacity to non-proportional. Meanwhile a shift in [primary] prices gave us some goodies for renewal,” he said, citing net premium increases in industrial business and a hardening of the local earthquake market. “We are encouraged by the first sign of original rate increases.”
Colleague Tomihiro Segawa, manager of treaty underwriting for the Asia division, expanded on the move to XoL. “Not long ago we had only reduced indemnity policies [in the primary market], but now the portfolio is predominantly non-proportional. Reinsurers' historic focus has been on proportional treaty, but with exposures constantly increasing without premium increases, the market can no longer absorb so much proportional.”
Some reinsurers, such as Cologne Re, have withdrawn from proportional altogether, while others are following Swiss Re's lead and urging clients to switch. Overall, however, the effort to migrate clients to XoL was not an overwhelming success. “Companies that already had an XoL buying strategy continued with it, but there was no great change in thinking this year on this front,” said Andrew Mellor, a catastrophe reinsurance underwriter at Wellington syndicate 2020. “We have reduced the number of our proportional acceptances over the years, and are now more focused on a handful of long-term partners whose needs and underwriting we understand. One or two companies had to increase their retentions, and thus bought more XoL capacity in the end,” he added.
“We downsized our proportional writings in Japan, and increased slightly on the XoL side, although we found it a little disappointing in certain areas,” said Robin Etheridge, a catastrophe underwriter with Amlin's Harvey Bowring syndicate. “At the end of the day, as we understand, most of the covers and programmes got fully placed, which emphasises the fact that there is still sufficient supply and capital to write that business.” It seems, however, that the capital has split into two camps: those willing to deploy their capacity for nothing less than a technical rate, and the rest, which includes some major players.
The completion of Japanese programmes was achieved despite the resolve of some reinsurers which found rates distastefully low. “We exited a couple of contracts where we didn't feel the risk-reward balance was adequate,” said a spokesman for US giant ERC. “We write catastrophe, but we have to do it in a framework that provides appropriate return for the risks incurred.” ERC is thought to have participated in eight large Japanese catastrophe treaties from 1 April 2001, down from ten the year before. The spokesman said some treaties brought rate increases of 25% to 40%.
Yet all business is not so clean-cut. Mr Segawa said Swiss Re employed a process he describes as “non-proportionalisation” to help bring pricing of its Japanese industrial earthquake book under control. “We tried to use non-proportional characteristics in our proportional treaties. We added loss and recovery limits, and maybe an event deductible. These non-proportional characteristics are new to proportional treaties.”
Mr Mellor observed the trend: “Most pro rata treaties had terms amended, such as reduced commissions and reduced event or cession limits. As such they became more attractive, especially with the improvements that are beginning to be seen on original business.”
At the moment, Mr Segawa said, Japan's proportional earthquake reinsurance is granted at prices much lower than those which Swiss Re deems to be technically adequate. “I suspect some of our competitors did not price these exposures adequately,” Mr Kaiserseder admitted. “If we don't get the price we want, we cannot come out with our maximum capacity, especially in earthquake.”
Quantifying the shortfall in earthquake rates is difficult since XoL programmes tend to have changed retentions and different coverage limits this year, with a rate on line of maybe 1%, while retentions under quota share treaties have increased as exposure has multiplied radically. Wellington's Mr Mellor reckoned earthquake exposure is underpriced by 35% to 40%. “Increases ranged from 20% to 30% on a like-for-like basis, given the changes in exposure and changed layering, but still this book is at about 60-65% of price adequacy.”
With prices too low to ensure abundant capacity, some of Japan's old practices have re-emerged, particularly that of offering ‘support business', profitable cessions which are intended to tempt reinsurers to take on less attractive catastrophe exposures. “We have seen resurrection of some support business behind some earthquake programmes,” said Takashi Goda, another of Swiss Re's Japan client managers. Ceding profitable business can increase the original insurer's expense ratio, but if it looks sufficiently attractive to reinsurers wanting to grow the top line that it attracts otherwise unavailable capacity (at the prices being offered, that is), it can be a cheaper alternative than paying for technically-priced cat cover.
Historically, goodwill support business was provided in proportion to cat business accepted, but the practice was terminated some years ago. It has returned, unofficially. “We have been lucky, and been able to retain some measure of unofficial support,” said Mr Mellor. “Terms have generally not improved on support treaties, and results have worsened slightly during deregulation years. But generally it is fair to say that the more profitable support fire business available, the more earthquake reinsurance capacity will be available.” Swiss Re confirmed that the resurfacing of support has attracted some new capacity. “Bigger reinsurers were clearly not very much attracted by this, because they wanted to price cat business properly, but for very small companies, the attractiveness of these offers triggered some new participations,” Mr Goda said.
Unfortunately for some reinsurers which accept underpriced support cessions outside a decent relationship, it is unlikely to provide a technical upside sufficient to cover the potential downside of the catastrophe book, meaning that in the longer term the opportunity is a loser. “Fire surplus treaties are not producing the profits the market was once proud of,” one observer commented. “A post-liberalisation price war in the primary fire market has driven prices down.”
Consolidation is another phenomenon which has shaken up the Japanese cat market. “In addition to the technicality of each and every programme, each reinsurer considered who they should bet on, creating an unscientific outcome,” said Mr Goda. “In some cases cedants were less technical, but some reinsurers put their chips on those programmes, and we found other cases which were vice versa.” The merger mania did not advance reinsurers' efforts to switch to XoL. “There were quite a few ‘new' companies that continued to favour existing pro-rata arrangements,” Mr Mellor revealed.
The mergers have affected the reinsurance buying patterns of some ceding companies, as outwards programmes are combined. Ultimately the effect will be serious, and already it is being felt. For example, Nippon Fire & Marine and Koa Fire & Marine, which merged in April, placed a consolidated fire treaty in overseas markets. By contrast, Mitsui Marine & Fire and Sumitomo Marine & Fire, due to finalise their mega-merger in October, opted to continue with separate programmes from at the latest renewals, although a source at Sumitomo has confirmed that the one-year treaties will include a six-month renegotiation clause.
As for windstorm exposure, Japan has seen the first general increase in wind XoL rates for many years. “In 2000 we saw some, but they were not market-wide,” Mr Segawa observed. “Those who suffered Bart losses had to pay more in 2000, the others didn't. We saw more rate increases in 2001, but rates are still a long way off those that we can consider technically acceptable. Therefore we have reduced our capacity yet again this renewal. Our list of treaties is getting shorter and shorter.” Wellington observed market price increases ranging from 20% to 70%, but saw an average nearer to 30% on its own treaties. “Our book is at about 50% of adequate on average, although there are some loss affected layers that pay much closer to technical,” Mr Mellor said.
Changes in the Japanese catastrophe market are well summed up by Ulrich Bley of Gerling Global Re's Treaty Department F. “Conditions improved for the reinsurers throughout all classes of Japanese business, especially in wind and earthquake. The shrinkage of catastrophe capacity was obvious,” he reported. However, “the expected move from proportional earthquake treaties to non-proportional did not reach a satisfactory level, but first steps and a slight change of the mind set in some companies might have been realised.”
Why has the success been limited, when such resolve was displayed? “I do think that most reinsurers were in the driving seat to improve conditions,” Mr Bley said, “but each on its own merits and, as usual, depending on the relevant client relationship.” So more is to come, as Mr Mellor concluded: “No client would have swallowed increases sufficient to bring their programme back to a technical rate. This renewal can be seen to be the first of two or three when reinsurance terms will improve to adequate – or more than adequate – levels.”