At the annual reinsurance gathering in Qatar, company bosses met for a frank conversation about the industry’s challenges
MultaQa 2011 presented an ideal opportunity to gather regional and global reinsurance executives to discuss the most pressing matters facing the industry. In a wide-ranging discussion, eight senior executives representing a broad cross-section of the market gave their views on how to tackle current market conditions, how underwriting should be improved and how they manage relationships with cedants.
- Yassir Albaharna, chief executive, Arig
- Charlie Cantlay, chairman, Aon Benfield UK
- Juergen Gerhardt, chief executive, Echo Re
- Michael Gertsch, chief executive, Gulf Re
- Hans-Joachim Guenther, chief underwriting officer, Europe and Asia, Endurance
- Peter Koerner, chief operating officer, ACR ReTakaful
- Salvatore Orlando , head of southern Europe, MENA, Africa and Latin America, PartnerRe
- Manfred Seitz, managing director, Berkshire Hathaway Group Reinsurance Division International
GR: How and where can reinsurers see growth in a soft market? Is it all about mergers and acquisitions now?
Manfred Seitz: There is very little growth to find in a market like this where you can look around the globe and virtually every territory and every class of business, with few exceptions, is unattractive from a pricing point of view.
While there have been some interruptions, rates have been falling for seven or eight years now. There was some impact of the financial market crisis in directors’ and officers’ [D&O] liability, but only for financial institutions. The rest of D&O is still on a slide, and rates are ridiculously low. Industrial fire business is rock bottom. Liability business in the USA is very low. Europe is very low.
The market correction in catastrophe business around the world – with the exception of Chile where it went up 50% after a major loss – is insufficient relative to the loss. We find little if any opportunity for growth. But growth for us is not a target in itself.
GR: What is a sound business strategy in this environment?
MS: One has to live with the cycle. If premium is no longer adequate for you to expose your capital, you shouldn’t. I know that is easy to say. A lot of organisations can’t do that – they have big staffs, big organisations with offices all around the globe.
It is difficult, but the industry requires underwriting discipline. In the current state of extreme overcapacity, this is not yet happening. I have been in the business for well over 30 years and I haven’t seen a situation like the one we have today. We had the financial market crisis, which in my view is equivalent to one-and-a-half or two Hurricane Katrinas, and nothing happened.
The insurance industry, at least from what I hear in Europe, is proud to say, “we didn’t cause the financial market crisis and we were not affected”. I have difficulty believing that when I look at asset value corrections and low interest rate levels, which are impairing our business very significantly. Additionally, loss cost will increase in an expected inflammatory environment.
Salvatore Orlando: Growth in reinsurance is not something that you have to achieve every year. Managing the cycle is much more important. Reinsurers are much more dependent on loss ratios than cost ratios. You can survive with a higher cost ratio, but you cannot survive with high loss ratios several years in a row.
Hans-Joachim Guenther: I totally agree. Managing the cycle is a science in many respects. You run models that allow you to determine comfortable ‘exit prices’ – the points at which you decide to withdraw from certain unprofitable lines of business.
Secondly, and even more importantly, you really need to understand the markets and your clients to create a sustainable business model. Opportunistic buyers present more of a challenge in a soft market. Long-term relationships with clients are more easily developed where you know you can mutually agree on the average price you need across the cycle. However, ensuring that the purchasing strategy of your client is not changing over time and becoming opportunistic is crucial.
Charlie Cantlay: I think it is incredibly difficult for a reinsurer to grow organically in today’s market. The smart underwriters are looking at new opportunities in product and geography, acquiring teams, or participating in mergers and acquisitions. Or they are simply giving their capital back and concentrating on the underwriting so they are positioned to survive and prosper when the market does change.
Michael Gertsch: The difficulty there is that you can’t be technically oriented and focus on cycle management if analysts, shareholders and rating agencies are still looking at growth as a measure of success. You can only execute cycle management if your shareholders agree and support that strategy and if the analysts understand there are certain periods in the life of an insurance company where growth is not good.
If you shrink your portfolio, you get penalised by analysts who compare you to your peers and say, “you’re not going in the right direction”. Then your share price goes down. As an organisation, you have to weigh those implications and ask yourself how much cycle management you can really do if nobody else does it.
SO: Our industry always focuses discussions on rates. We also need to talk about exposure. I believe we are going to see some changes in the market over the next couple of years.
MS: It is worth looking at industry-wide and individual company results in more detail. In 2008/09, we had the financial market crisis. In 2009, results for the industry were rather positive. Why? Because the business is so sound? No. It was more by chance, because there were no natural catastrophes whatsoever and asset value corrections, as well as low investment yields, had not yet fully materialised.
In 2010, it was a mixed picture. Some Bermudian companies suffered impairment because their investment income declined due to their investment profiles, which are somewhat different from those of continental European reinsurers. Continental reinsurers, on the other hand, had comparatively good results – again not because the business was so sound, but because of financial gains and increased values of existing bond portfolios with higher yields.
Is the industry’s business model okay, therefore? The answer can be found in analysts’ valuations of reinsurance companies. Why are most reinsurers trading at or below book value?
Yassir Albaharna: Over the past two years, rating agencies have maintained a negative outlook on the whole reinsurance business – without exception. So we are doing something wrong in their eyes?
GR: Do these outside observers fundamentally misunderstand the business, perhaps?
MG: We are operating in an industry that has a very short memory. When we talk about pricing, we like to talk about areas: this area has no losses. Well the area will have losses eventually. And that is what a lot of people don’t understand. If you just have one or two good years as a reinsurance company, that doesn’t mean that the underlying business is sound. You might just be lucky.
But the exposure is there and I think the really dangerous thing is when we start to get frequency of severity losses. I believe that, in general, the quality of the business is improving because we are learning from our mistakes, but the exposure is still there.
MS: When you look at the past couple of years, we had losses outside the main catastrophe scenario zones – Chile, New Zealand, Australia. We did not have any catastrophes in the major exposure areas such as US hurricane, California earthquake, Tokyo earthquake or European storm. Now, with the Japanese earthquake, this is moving closer to the classic top exposure areas.
With all that has already happened in 2011, if some large event occurs in one of the classic exposure areas during the remaining three quarters of the year, you would have a real scenario – I think that would definitely turn the market.
CC: I totally agree with that. As we go into 2011, the market is more fragile than it has been for many years. If there is a storm or another quake, given that most people have got close to exhausting their catastrophe budgets already, the effect would be very significant.
HG: One of the underlying reasons for cycles being less volatile than in the past is that the influx of fresh capital is much easier and much more fluid than it was 20 years ago. This is a danger in itself, because it limits our ability to set economic terms that would allow us to earn an appropriate risk adjusted return.
Peter Koerner: When we look at losses, we always talk about return periods – whether an event is one-in-100 years or one-in-250 years. We assume we can get premiums for 250 years to pay for losses, but we cannot. More capital comes in that is happy to write the business at much lower rates.
SO: Good point. That means the product must be changed.
GR: Is anyone changing the product?
CC: Underwriting is both art and science. I think the science should inform; it should never be the basis of a decision. Unfortunately, too many people in the past 10 years have used the science as the basis for their underwriting. There is no substitute for 30 years of underwriting experience to overlay the science.
MS: It is relatively easy in today’s world to underwrite and price risk according to model results provided by various modelling companies. Models are a positive development and may be helpful for guidance. However, they cannot substitute time-tested risk assessment and pricing techniques developed in the (re)insurance industry over many decades and individual underwriting experience.
HG: Let’s not forget too that models also create a kind of artificial transparency between reinsurers and cedants. If we decided that a 50% load was appropriate to compensate for the uncertainties in a piece of business, competitors could differ in their assessment of the risk of uncertainties and charge a lower rate. In this way, cedants would have a good idea of the exit price of the existing market.
The belief in modelled numbers unfortunately led to the commoditisation of our business. The transparency of the pure risk price is something you will not find in any other industry to this extent.
YA: The solution is in our hands. We are the ones who chose to underwrite this business. We are the ones whose shareholders have given us the capital to underwrite. If clients are not listening to us, I think we only have ourselves to blame when we choose to disregard business fundamentals. We have capital and we need to service it, but that comes at a price.
MG: There is a tendency to try to calculate everything. There are tools and systems available, but so many assumptions are going into them. That is when underwriting comes in.
When you talk about cycle management, it becomes increasingly important to underwrite, because if you went by pure pricing, you would not write any business any more. There is still business out there that can be written, but you have to underwrite – find the reasons other than price why a risk is better than the normal model and so can be written.
A lot of companies are struggling with this these days and are calling for technical underwriting. It’s almost like people have forgotten what underwriting is. Taking assumptions and pricing is one part of it. The modelling is one part of it. But then you sit down and you take a decision for certain other reasons and factors.
HG: The pure belief in modelled numbers was a step towards commoditising our business and that is not playing out well.
SO: One area of growth we have experienced over the past couple of years has been longevity business. There, we can find some interesting, decent business. Buyers are willing to pay a certain price because they can’t predict the future. I think it is a fair business environment. Buyers have a problem, you can give them capital or a product, and they will be prepared to pay.
Juergen Gerhardt: It is no use hopping from one treaty to the other, one year to the other. You should build up a long-lasting relationship with the client and you can also ask the client for compensation if you have a loss in one year that would overcompensate what you had shelled out.
PK: It is very difficult to find long-term treaties over three years or so, because companies don’t like to commit.
YA: We are happy to give buyers the terms and conditions that will ensure such a long-term relationship. But unfortunately there are no takers – continuity cannot be one-sided. So the treaties continue to be for 12 months and subject to an annual review.
GR: Are clients fickle?
CC: People continue to use the word continuity. I think it is a much overrated phrase. It is not reasonable to expect people to carry on buying from the same partners time and time again if there is a loss. You hope that there is loyalty, but I think we should get rid of the word ‘continuity’.
I think people are setting out their product, their coverage, their price on an annual basis. You have to make annual returns to your shareholders, and that is pretty much the way people buy. But there is an overlay of loyalty.
HG: I agree. Loyalty is often still out there, but it is not always translated into continuity. This is what good underwriters with in-depth knowledge of the marketplace are able to assess, because there are behaviours you can observe with clients.
I’m not saying you can trend it out, but you get a feeling for what kind of philosophies a client seeks in its reinsurance partners. That helps to build your book. The continuity that might have been in the market before I started my career is definitely gone.
CC: If you go back 20 years, the contact between client and market was minimal. Now it is intense and we absolutely encourage it because what you are trying to foster is a partnership approach, within certain parameters, between your carrier and client. In all my experience of the market, a partnership approach ultimately does better for a client than an adversarial approach between reinsurer and client.
SO: I think the market has changed completely. Twenty to 25 years ago, the continuity factor was driven by the fact that most of our clients were linked to a Swiss Re or a Munich Re. They were the lead reinsurers. Today some reinsurers like to continue to say, “I’m the leader”, but who is the lead? Lead doesn’t exist any more.
MG: The role of the broker has also changed. When you go back – when I started in this market 25 years ago – the broker was an intermediary. He was trying to create this path between the reinsurer, the insurer and the client. These days, the role of the broker has changed to getting the best deal for the client.
CC: I would add that the advisory role rather than just the transactional role has become critical to brokers. Occasionally, we will say to a client, and it may not be in our best interest at all, “you are better off not buying anything”. We don’t get paid for saying that. But if you are going to be a broker with a long-term future, you have to make decisions that might not be in your short-term interest to build up the longer-term value the client will put on your advice.
PK: To get the best deal, we all agree that it is the cheapest but maybe there is a bit more to it. It can be expensive to change horses every year. What are all the costs of changing your leader, and how often can you do that?
SO: I don’t think a lot of people calculate the costs of change. They may have no idea what the implications around this are. The key decision-maker may not consider the additional cost burden they are adding when they decide to change a business partner. This probably is more affordable in an emerging market because of cheap labour, but in mature markets those changes are extremely expensive and under-estimated.
GR: Where does the broker’s duty of care lie when a reinsurer undercuts the incumbent and they want to move?
CC: The broker’s duty is very clear: it is to give advice to the client about where the best coverage and the best price lies and to clearly explain to that client what the ramifications are, were they to change from that market to this market and explain every aspect of that.
Gone are the days, if they ever existed, where the broker would try to favour a particular market. If you start doing that, you might as well go and sell cars. That is not the business we are in. We are in the business of giving what we believe is the best impartial advice to the client.
Sometimes that may involve saying: “you may want to think very strongly about moving from this market that is charging a higher price, because they have been with you for this period of time and they have stuck there, but it is your call”.
It is very rare these days that a broker gets the chance to put a market of their own choice onto a slip. Nearly all of our slips are dictated by the clients, or at least signed off in terms of who we are going to see. It is a much more controlled process than it used to be.
If we took an arbitrary decision not to offer a renewal, we’d be fired instantly, and rightly so.
GR: How do clients make their decisions? Is it solely price?
CC: Some are entirely short-term price-driven, and it would be foolish to suggest a lot of the clients we all deal with aren’t in that group. It is probably some of the medium to larger clients who value a relationship with a market that they have had for many years and want to keep it, so occasionally they will pay more. GR