Good News – Bad News from the Reinsurance Rendezvous

Generally speaking the reinsurance industry is in good shape, certainly better than it was in 2008 and 2009, when even mighty Swiss Re needed a bailout from Berkshire Hathaway.

A combination of improved models and a greater understanding as to how they should be used has resulted in more accurate and disciplined underwriting, as well as better risk management.

S&P characterizes the sector’s enterprise risk management (ERM) as having more advanced “capabilities than the rest of the industry.” Diversification has deepened the sources of revenue, both geographically and by line of business. As a result stress tests, such as A.M. Best’s Capital Adequacy Ratio (BCAR), underline the reinsurers’ basic soundness.

Under such conditions, one would think that the 55th Annual Reinsurance Rendezvous in Monte Carlo, which wound up last Wednesday, would have been a non-stop celebration (which in some ways it was).

Such was not the case, however. In presentation after presentation industry leaders, while pointing to some facets with pride, also viewed with alarm a number of factors that concern reinsurers. It seemed that for every plus, there was a minus. Here are some of the subjects that constituted the good news and the bad news.

All of the brokers: Guy Carpenter, Aon Benfield and others; the rating agencies: S&P, A.M. Best, Moody’s and Fitch, and most of the reinsurers present, headed by Munich Re and Swiss Re, have accepted that insured losses for the first half of 2011 are approximately $70 billion – bad news.

However, they have also concluded that, except for some individual cases, the losses are “earnings events,” i.e. they will make less money this year, rather than “capital events;” therefore the reinsurance industry still has plenty of capital [the top 40 have more than $350 billion] – good news?

Not entirely, as overall they actually have an excess of capital, which means that while rates have risen in areas particularly affected by catastrophes, they haven’t risen elsewhere, and may in fact be declining, especially in the area of casualty coverage – bad news.

But: If there’s one more big cat, coupled with the economic crisis, the low level of interest rates (i.e. investment returns are zilch), increasing regulation in the form of Solvency II in Europe, FSA reorganization in the U.K and stricter accounting standards, primary carriers might have to cede more to reinsurers, and rates might go up – possible, if somewhat iffy, good news.

Diversification is a good thing, as it opens more lines of business. It has resulted in “smoothing volatility,” according to A.M. Best, as well as making pure reinsurers a threatened species – good news.

However, Best also said diversifying increases execution risks and “distracts” a company from its core business – bad news.

The lingering crisis in the economic and financial sectors in Europe and the U.S. was almost universally viewed as bad news. Low interest rates on debt instruments, especially highly rated government bonds mean they yield far less income than they used to. “The [reinsurance] market hasn’t priced in low interest rates,” said Swiss Re’s Chief Underwriting Officer, Brian Gray, who also described the situation as a “real shock for the industry.” He warned that if the low rates are not “compensated for by significantly lower combined ratios,” the reinsurance industry’s earnings capacity “will erode over time.” – Bad news indeed.

Innovative new products were seen as generally good news. “We need product innovation,” said Torsten Jeworrek, Munich Re’s Reinsurance CEO. “We need to respond better than in the past,” essentially by focusing on possible “surprise risks” and “new exposures.” – good news.

However, one of the areas he focused on, where substantial growth has been anticipated, is business interruption [BI] coverage, and particularly its close cousin continued business interruption [CBI] coverage; i.e. policies that cover the losses a business suffers from supply chain interruption, as demonstrated by the Japanese earthquake and tsunami.

Unfortunately, as Aon Benfield’s Chairman Grahame Chilton said, the market for CBI is just “not there” – at least not yet. The main problem in selling the coverage is that it’s very hard to price, as each business is different, which means it tends to be quite expensive, and most businesses aren’t convinced that they need it – bad news.

Perhaps the most cogent view of the current reinsurance market came from Peter den Dekker, the president of the Federation of European Risk managers (FERMA), and the risk manager for the Netherlands Stork BV. As a member of the panel in a conference organized by Munich Re, he reminded the overwhelmingly re/insurance audience who its main clients are. Those clients are not “just focused on price; what your customers want is capacity, solutions and availability,” he said.

He added that there are over 4000 large commercial companies in Europe, and they don’t particularly want “raised prices.” If there’s a good reason for the raises, and it’s explained to the clients, they will probably accept it, but, “if the price isn’t good, chances are the coverage won’t be written.”

Focusing on the larger picture is always a good idea, as well as good news.