Keith Shroyer says Latin America's premier reinsurers will be companies with quality, financial strength and superior underwriting teams.
For all the starts and stops associated with conducting business in Latin America, it continues to be one of the most resilient, determined and tough-minded business cultures among the emerging markets. Offering some favourable news, the World Bank has projected 3% gross domestic product (GDP) growth for Latin America in 2003, which is very encouraging for business leaders who have weathered a difficult couple of years.
Within the Latin American reinsurance industry, three major trends have been underway for the last several years - with notable acceleration during 2002. They are market consolidation, a flight to quality and new realities for profit making. The confluence of these factors is creating a survival challenge for market participants - both insurer and reinsurer - the fallout of which has already become evident.
The reinsurance consolidation process is widely expected to continue at full speed in Latin America, as it has for the last couple of years. Corporate mergers, acquisitions, market consolidation and withdrawals in the reinsurance sector are dramatically reducing the number of viable players in Latin America. Well-known reinsurers with respected track records make the news regularly with their departure or ratings downgrade announcements.
As coverages become more and more scarce, and as pricing becomes steeper, insurers experience heightened pressure to protect themselves. While the laws of supply and demand are driving rates upward, programmes offering better security and quality of coverage are costing more.
The tests for leadership in Latin America are very straightforward - reinsurers must have the ability to quote and lead programmes, or accept substantial shares of those programmes, and they must offer the capital and financial security to do so viably. Among the major multinationals, only about five or six are able and/or willing to assume that leadership role. The level below is comprised of companies with lesser financial security ratings, which claim interest in leading programmes but which do not have the financial wherewithal to execute them. Knowing the difference and selecting a partner accordingly is essential to survival in this climate.
Flight to quality
At a time when specific risks are being assessed more carefully, securing adequate coverage has become a chief concern for many ceding companies as year-end renewals approach. Some reinsurers are undergoing, or have already suffered, ratings downgrades - causing ceding companies to scramble to replace their programmes with the best security possible. More than ever, cedants must look closely at the overall financial strength of their partners on a region-by-region basis.
This quality bias also applies to the three core reinsurance segments - facultative reinsurance, catastrophe excess of loss and proportional treaty. Among the top-rated security reinsurers, fewer and fewer are remaining steadfastly dedicated to the proportional treaty business. Even with the new Bermuda capacity, most reinsurers prefer to target catastrophe excess of loss business. As a result, the proportional treaty business is seeing a scarcity of players, at least among those with higher ranking financial security. Together, these factors intensify the market competition among insurers to get that top-ranked security on their programmes.
Some forecasters believe that, a couple of years into the cycle, the hardening in the catastrophe excess of loss side will slow somewhat. However, the velocity on the proportional treaty side continues to be quite considerable. As for the facultative business, much depends on the individual risk and the country-specific environment to determine the degree of price firming. The difficulty of placement depends totally on these factors and must be made on a case-by-case basis.
Underwriting is king
In only the last five to six months, the fundamentals of profit generating in our business have changed substantially, or rather have returned to the operating principles of yesteryear. In many ways, it's `back to basics' from an underwriting viewpoint - augmented by advances in technology, with rating and analysis models that allow underwriters to perform a more precise analysis of the business under consideration. With more intelligence and market data, underwriters - rather than creative financiers - will be the ones to lead committed companies through the current market cycle.
To realise any substantial improvements in the health of the industry over the mid- to long-term, the very premise upon which profits are made will have to reflect the economic conditions of the markets. A driving factor in this scenario is interest rates, which are at all-time lows in the US and Europe and are expected to remain so for the next couple of years. Compare this situation with the last hard market cycle from 1992 to1994. Ten years ago, interest rates were much higher, which meant that reinsurers could have marginal underwriting results, yet still make respectable overall profits through increased volume. While the underwriting result was marginal - maybe a couple of percentage points - the investment income from that revenue stream was substantial. Back then, it was common that the bulk of the annual profits came from investment income once the books were closed. This would be the case for reinsurers as well as the primary insurers. In this current interest rate climate, companies will have to generate revenue through significant underwriting profits because invested income no longer offers an adequate pay-off.
Looking back at the first quarter of the year, several of the multinational reinsurers were projecting favourable results for 2003. Once mid-year results were reported, companies were revealing highly diminished results from their investment funds. In spite of all the upward pricing conducted at 1 January and before, it was still not enough to offset the fact that investment performance was dropping dramatically. These industry losses were not widely foreseen. In April, the market consensus was: "These companies are doing fairly well. They closed with a decent first quarter and are on their way to recovering as long as they don't have additional reserving problems from September 11. The market seems to be on its way to recovering." But with the release of June results, the true investment picture became evident. Instead of showing a good result at 30 June, almost the entire market released unexpectedly disappointing returns.
With financial professionals anticipating that this investment climate and interest rate environment will prevail for at least another couple of years, reinsurers will be forced to conduct business at much higher prices in hopes of riding out this trend. When measuring this trend against specific lines of business, pressure can certainly be noted within property, mainly due to catastrophe exposure and the increased rate of frequency of catastrophic events worldwide.
More importantly, large economic pressures within the industry have placed the market's attention on the quality of an underwriting operation and its ability to remain firm during the next couple of years in markets like Latin America. The relevance for cedants is recognised `on-the-ground' through key, quantifiable factors like local underwriting talent and cultural or historic insights within particular markets.
As in all markets, Latin America's reinsurance industry will be sustained by companies with quality financial strength, accompanied by superior underwriting teams that are equipped with the tools to properly analyse the business. It will be these measures that define the premier reinsurers.
Brazil: the saga continues
The Brazilian reinsurance market is back in the news. In mid-October, the government confirmed that the IRB privatisation could not take place (IRB-Brazil Re is the government-controlled reinsurance company that has held a monopoly for several decades). The Supreme Court recently ruled that the procedure under which the privatisation was scheduled to be executed was unconstitutional. Therefore, the privatisation would have to take place by "a complementary law." In all probability, the IRB will remain in its present hands.
The reality of this situation is allowing market decision makers to move beyond the privatisation issue and seriously address complete removal of the linkage between privatisation and the general opening of the market - a more reasonable expectation. Market observers anticipate this type of opening for foreign competition to be a possibility, with greater opportunities for foreign reinsurers in the near-term.
As always, a precise time frame is impossible to predict. The Brazilian president-elect, Luiz Inacio Lula da Silva, will enter office in January, and the opening of the reinsurance market is not likely to be on the top of his agenda. It is widely felt that the market opening will not happen before 2004.
Argentina: cautiously evaluating
Argentina continues to struggle through a very difficult situation, mainly related to economic uncertainty. Some reinsurers, including XL Re Latin America, continue to be very actively involved in the market and are working hard toward supporting the country's needs.
It is estimated that, before the Argentine economic situation dimmed, approximately one quarter of the insurers in the market were on precarious financial ground. Now, post-devaluation, the estimate is closer to three-quarters.
In general, prudent market participants are operating a little more cautiously in terms of programme analyses and structuring. Many reinsurers are using this slowdown to reassess their approach to the market and then move accordingly. Reinsurers, eager not to move hastily, are fully analysing the evolving economic impact, as well as the balance sheet and financial condition of the insurer under consideration.
The country's presidential elections were moved forward to March 2003 from October 2003. The winner of those elections may be able to foster an environment of enhanced stability with an air of confidence in the economy going forward.
Mexico: a time for justice
Overall business conditions in Mexico are steadily improving with the exception of one situation that is seriously damaging the country's credibility and professional image - with specific impact on the insurance sector.
A case is currently evolving wherein an insured is claiming loss legitimately, but trying to recover much more than entitled. A judge from a rural part of Mexico has issued an arrest warrant against the top executives of the issuing insurance company. This warrant was issued without the provision of a hearing for the company or its executives and was based on false accusations and without regard to the insurance company or the facts relevant to the claim. Hearkening back to Mexican governments 100 years ago, this type of unjust, unilateral action is totally unheard of procedurally in any fair court system in Mexico or elsewhere - all of which is creating a serious lack of credibility for the market.
The broader tragedy is the tarnishing of the Mexican insurance market, which has worked long and hard to overcome stereotypes of backward practices and corrupt governments. The situation is highly embarrassing, not only for the insurance sector but also for the country's business community at large. Foreign investors look on with shock to see that Mexico - in this day and age - allows a judge to issue an arrest warrant with no grounds, based upon falsified documents.
The Mexican regulatory authority has taken the lead to vehemently oppose this procedural injustice. Nonetheless, the insurance industry remains the victim. Until a lawful hearing and appropriate legal measures are taken to evaluate the case on its facts, the market is left to bear the brunt of negative perception.
By Keith L Shroyer
Keith L Shroyer is the president and chief underwriting officer of XL Re Latin America Ltd. Prior to this, he was one of the founders of Latin American Re and served as senior vice president and chief underwriting officer from 1997 to 2000. Mr Shroyer spent more than 20 years working in the Latin American markets at American Re. During this period, he built the Latin American Division of American Re to become one of the most prominent reinsurers in the region. In 1999, Mr Shroyer was recognised by the Financial Times as the leading figure in global insurance and reinsurance for Latin America.