When major losses such as the 1988 Piper Alpha catastrophe and the 1989 Exxon Valdez disasters hit marine insurers in the late 1980s and early 1990s, their effects reverberated across the whole London market. As a subscription-based industry – as London was at the time – underwriters across the market shared the losses, and this in turn was spread further afield through widely-placed reinsurance programmes.
However, in today's mainly non-subscription market, fewer Lloyd's syndicates and London market companies are being harder hit by two recent and very significant losses; the sinking of the world's largest offshore oil platform Petrobras P-36 in March, with a total insured loss of $496m, and the more recent terrorist attack in Sri Lanka that resulted in the loss of two A340 and an A330 aircraft, with hull values totalling $357m, as well as serious damage to other aircraft. The impact of these losses has been amplified because they occurred close to each other and following a long period of relatively low losses. This quiet period had resulted in a softening of rates and conditions, consequently exposing underwriters to greater losses than would previously have been the case.
Fewer hit harder
With fewer markets writing increasingly bigger lines, and many underwriters, already under pressure due to higher reinsurance costs, facing increased strain on their balance sheets, these losses are being felt harder by a smaller number of insurers. As a result, more competitive market forces are coming in to play. This is leading to an interesting new dynamic emerging, with the markets which have escaped these losses having greater rating flexibility and ultimately creating a more competitive marketplace. Sooner or later this will impinge upon the business viability of many, and the end result is that capacity is already withdrawing from the marine excess of loss (XL) market.
How the sector is going to cope with these new market forces will be interesting, but underwriters are now reviewing the business areas they are currently trading in.
Adding to these pressures, there is little doubt that the reinsurance market will impose greater restrictions and will be less inclined to write all inclusive whole account protections come the next renewals. Rate increases are likely, and underwriters will have no choice but to retain more risk rather than cede it to their reinsurers. We also expect reinsurers will reduce the size of some of their lines.
Although the maze of ownership of Lloyd's syndicates has changed, the overall capacity of the market has not, and at the moment it is unclear who will remain in the shrinking marine XL market. It is estimated that about £700m of the existing capacity for the whole Lloyd's composite and marine market is uncertain for the next renewal season. With several high profile underwriters yet to reveal their hands, there is plenty of speculation about the level of marine XL capacity for 2002. However, what is certain is that rates will be affected whatever these underwriters decide to do.
It is likely that the market for non-core opportunistic deals will be much harder to come by, and many reinsurers will impose restrictions on cover. The demise of Independent Insurance is also going to have an impact, since a number of Lloyd's marine syndicates were involved in reinsurance arrangements with Independent. Market controls are far greater than ever before and there should be fewer surprises than in the past. Individual insurers' positions should be clearer, and loss scenarios predicted and planned for at a much earlier stage. However, with corporate capital coming increasingly from fewer but larger market players backing the syndicates, Lloyd's faces an increasing challenge on how to impose restrictions on companies that are now bigger and have more muscle than the market itself. This unhealthy imbalance could bring a new set of problems for Lloyd's which are likely to emerge over the coming years.
So what is the answer for underwriters and companies trying to ride out this turbulent market? In such circumstances, markets should be looking to brokers with solid core books of business, who have invested in strong market relationships and have a depth of knowledge and market experience. This is not a time for a rash approach; instead a professional and more cautious one should be pursued. Companies that can demonstrate a solid and reliable track record and market position, combined with demonstrable integrity, will be in much demand by buyers wanting to place their core reinsurance programmes. Three to four years ago, the more forward-thinking brokers took a conscious decision to target quality reinsurance business and it is at times like these when this strategy pays dividends. These brokers will have recently reviewed the likely position of their expiring markets for the next renewal season and will be heartened by the remarkably low level of fallout, which supports this theory.
Another area where help is required is with finite risk solutions for low-level attritional losses. With the current harder market conditions, reinsurance cover for these types of losses is rapidly drying up and this, combined with the time lag effect of the last three years' losses, means yet more pressure on underwriters' cash flow. Finite solutions can help ease this pressure and offer a financial crutch. One year back there was less demand for this kind of programme, but today's market conditions have transformed the economics of low level reinsurance; companies cannot afford to have volatile results and need to protect share value. These programmes help smooth out capacity shortages, hedge against bumps in pricing and manage the claims experience. Typically the policies last three to five years and are long-term solutions rather than an annual stop-gap. However, the solution has the ability to evolve as it responds to wider market conditions. Another big asset that these finite solutions brings is that people can still obtain cover for 2001 as well as 2002.
Reasons to be cheerful
Despite hardening markets, shortages in capacity and certainly tough times ahead, the picture is not all gloom. The hardening reinsurance market should offer direct insurers opportunities to return to profitability and should shake out the quality players from the pack – and this has to be good for the market as a whole. There is no doubt we are facing a very challenging renewal season, but experienced and professional brokers should be confident of getting core reinsurance programmes home. It is times like these when we will all be tested and the quality brokers can really prove their worth.