With a soft market seeming inevitable, businesses will have to rely for survival on good practice built since the chaos of the late 1990s. But both brokers and underwriters will also need to adopt unprecedented levels of care and caution
There has been much talk in recent weeks about the size of catastrophe loss that would be needed to reverse the general downward trend in reinsurance rates. The figures being discussed are huge: $50bn or more. Given the passing of the equinox and the cooling of sea temperatures, the chance of a massive and costly Atlantic storm before the renewal season is decreasing, and the likelihood is that reinsurance rates will soften further and possibly reduce to a level that can, for the first time in almost a decade, be described as a soft market.
The last soft market, which ran from around 1997 until 2000 or early 2001, caused many problems for the reinsurance sector. Whether undisciplined underwriting is what causes a soft market, or if it is the product of a reduction in rates, is a matter for debate. The fact is that during the period 1997-2001, there were numerous instances of undisciplined underwriting that created severe problems for the companies involved and for those doing business with them.
While headlines were made from problems such as the personal accident spiral and the film finance fiasco, there were also numerous incidents when underwriters wrote business that should never have been written, on totally unacceptable terms, simply because they felt an obligation to utilise the capital available or because they felt that they were able, somehow, to exploit a gap in the market and outperform their competition.
These mistakes took many years to unravel. In some instances, it was held that the underwriters were the victims of sharp practice and in others that the underwriters’ behaviour itself was worthy of rebuke. Either way, the uncertainty of litigation or arbitration, together with its cost, cast a shadow over many members of the market for quite a while.
The soft market of 1997-2001 was not alone in giving rise to issues. Indeed, an examination of the timing of soft markets going back to the 1970s shows that every soft market has given rise to a flurry of disputes caused by underwriting or broking indiscipline.
If rates are decreasing today to the level of a soft market, two questions arise. The first is whether market conditions and infrastructure have changed sufficiently over the past decade to allow the market to avoid the abuses of the past. The second is, if indiscipline is inevitable in the marketplace, what can individual companies do to avoid those problems?
Since 2000, the market has changed substantially. Regulators and the ratings agencies have imposed minimum standards upon the industry that have created huge margins of solvency. This will, at the very least, minimise if not eradicate the domino effect of insolvencies that occurred in the early 1990s. Companies themselves have implemented enterprise risk management (ERM). Checks and safeguards are in place. Underwriters are no longer a law unto themselves, but must report every risk to be scrutinised. It is fair to say that the market is well placed to face a soft market.
It must also, however, be recalled that in 2008 the banking industry was subject to regulation, rating and ERM, yet these were not sufficient to protect that industry from catastrophic failure.
Sadly, regulation, both formal and informal through rating agencies, cannot protect against every rogue broker or underwriter – and neither can ERM. Market-wide issues are not the only threat to a company. One badly written risk has in the past, and will in the future, imperil a company’s solvency. In soft market conditions, one must apply additional caution to the way in which business is done and not rely simply on ERM. Weak premium rates will lead to losses, and losses to disputes. No one disputes a profitable contract. A counter-party hit by its own indiscipline will seek or be forced to recoup its losses elsewhere.
Careful underwriting coupled with additional caution is required. Maintain evidence of every conversation, however banal, as that evidence may be essential in proving a case. Keep records, particularly models and calculations. Record why decisions were made and upon what information.
Most of all, avoid deals that are too good, particularly reinsurance that is too cheap. Look carefully at wordings and ensure that they reflect the bargain that has been priced. In an uncertain time, do not enter new markets or try to take on new classes of business.
If the market does soften, problems will arise. The survival of any business in this environment requires investment in caution today. GR
Clive O’Connell is a partner and head of the commercial risk and reinsurance team at law firm Barlow Lyde & Gilbert