Swiss Re’s Chief Economist Analyzes a Difficult Reinsurance Market

By | September 22, 2014

Over the past 13 years Swiss Re’s Chief Economist, Kurt Karl has been through a succession of reinsurance market ups and downs, but the current situation is somewhat new, and, as he told the IJ at the Reinsurance Rendezvous, it requires special handling.

It’s no longer possible to simply offer traditional reinsurance without something more, beginning with reinsurance services as the market itself has been restructured. “In this kind of market what we do is we find and service our clients as fully as possible from the reinsurance side,” Karl said. “That includes extra capital, if they need it of course, but that’s the easy part.” The harder part requires cooperating with and guiding Swiss Re’s multitude of global clients.

Karl said Swiss Re will also “provide training, help them [clients] enter new markets; we’ll help them with new product initiatives, underwriting expertise, actuarial training.” He also agreed that learning to use and profit from “big data and analytics that can help all of us do a better job in underwriting.”

Not only is the reinsurance market still dealing with extremely low returns on investment, but also with a large amount of additional capital that has depressed rates, as well as political turmoil in many parts of the world, which Karl described as “sort of a low burning loss issue.”

Nowhere are investment yields lower than in Europe, where some central banks now have a negative interest charge for banks who park their money in the central banks instead of lending to their customers.

Karl remains somewhat optimistic, however, that there will be positive movement in the near future. “Yields are rising,” he said, “and we expect the Fed [the U.S. Federal Reserve Bank] to be moving early next year; the bank of England early next year; the European Central Bank probably early 2016, because of the weak economic activity in Europe.”

While waiting for movement in those mature markets, Swiss Re, along with the rest of the reinsurance community, must also devise strategies to deal with the “turbulence” in a number of emerging markets. The re/insurance industry has long been attracted to the growth potential in new markets, but they do present a number of risks.

As a diversified reinsurer, Swiss Re now has a presence in a number of emerging markets in Asia, Africa and Latin America, which Karl said it considers essential for future growth, despite the problems of doing business in countries that are quite different from Europe and North America.

“The key thing that we all forget is that these are exciting markets,” he said. They’re growing sometimes 10-20 percent per year on the total premiums. It’s really quite amazing, but it’s a very small market – small economies, small insurance penetration; not a lot of premiums for the total output of the economy.

“As a consequence you have to get into all of them, and as a large player we certainly try to do that, because the diversification is quite severe on products, regulatory regimes, governance issues with respect to how the government wants to play; how much you can buy of a local reinsurer or insurer with respect to foreign direct investment.”

Karl indicated that most of Asia is “much further along, a much bigger market, but some of the countries are quite small, but we’re getting involved in those as well.” Most Asian counties have shown “strong income growth for the last decade,” he said, “and we expect that to continue to continue. By 2017 in our forecast Asia will be the largest region for insurance –primary insurance – so more premium volume, including Japan and the developed markets as well.” Growth in Asia is “triple what we get in North America, and maybe four times what we expect in Europe.

Africa, however, is a “20-year play,” Karl said. “You have to be in there; you have to build the relationship, and 20 years from now you’ll be doing well.” Overall the economies of the countries in the African continent are growing at around five percent a year, as they invest in infrastructure, mining, power plants and local industries, all of which create a need for re/insurance.

“As income goes up you get higher and higher penetration,” Karl said. “It’s a very strong correlation, but varies of course from country to country. Some countries get very keen on insurance and it grows very rapidly, while others come along more slowly.”

He also explained that growth can be achieved not only from geographical expansion, but also through expanding product lines, notably in the casualty sector. “We think it’s going to turn a corner,” Karl said. “Essentially we’ve seen, especially with respect to the development on accident years, an ‘improvement’ in claims.” He explained that this consisted of relatively fewer claims being through 2004 to 2007. As a result Swiss Re had fewer losses than it had anticipated for those years, and the excess funded reserve releases, which bolstered profits in both insurance and reinsurance.

Since those years, however, claims have been more or less in line with expectations, and could possibly exceed them. “This implies that we’re running out of positive reserve releasing and could get to adverse development soon,” Karl said.

In addition economic activity is improving, albeit slowly. While it’s relatively strong in the U.S., less so in Japan, and relatively weak so fa in Europe, it’s nonetheless happening, which, Karl explained will cause unemployment rates to decline and possibly create some “wage inflation,” which is directly linked to liability. Medical service costs are already rising, which will tend make the claims get higher,” i.e. “adverse development, and more interest in protecting yourself.”

Returning to the state of the reinsurance industry, Karl described it as “being in pretty good shape;” adding that the “key issue – depending on the cat developments in a particular year – is the challenge to profitability.” So far the relatively benign years for natural catastrophes, coupled with the reserve releases have resulted in “profitability on borrowed time,” but “these conditions will inevitably disappear.”

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