Staying On Top Of The Reinsurance Market
By Laura Beller
The majority of agents find themselves far removed from the reinsurance transaction, so keeping abreast of current reinsurance trends may not seem like a top priority. But Mike Schell, senior vice president for North American Underwriting at St. Paul Re in New York, believes agents should stay abreast of trends and changes in the reinsurance segment. "Agents, as part of their understanding of the business and what they need to do to anticipate the needs of their clients, should keep a cursory understanding of what's going on in the reinsurance market," says Schell. He notes that by staying current on reinsurance developments, agents are able to take a more proactive stance in managing their business. And what's more, agents can anticipate the need to find different markets with which they can place their business, thus providing an edge in servicing clients.
Schell uses the liability crisis of the mid-1980s and Hurricane Andrew to demonstrate his point. "In 1985 and 1986, agents lost a lot of the casualty market for different kinds of commercial risks; there was an extreme reduction in casualty support for commercial risks. In 1993, agents lost support from many of their insurers for hurricane-exposed risks in the Southeast following Hurricane Andrew," Schell notes. This happened again with the 1994 Northridge Earthquake. He goes on to say that the leading driver behind these pronounced contractions in the availability of coverage was really a short-term reduction in reinsurance capacity.
Four dominant trends in the reinsurance segment have an impact on the business of agents and insurance companies. These trends are: the "flight to quality," the changing catastrophe market, aggressively-paced reinsurance consolidations, and continued growth in the alternative risk transfer market.
Flight to quality
The "flight to quality" trend got its start in the mid-1980s, as a result of the problems insurance companies had with uncollectible reinsurance. Schell recalls how, in the early 1980s, insurance companies bought a lot of "cheap reinsurance" at rates that they knew were inadequate. Then, when a few of the reinsurers went broke, it left many primary companies having uncollectible reinsurance problems. According to Schell, St. Paul Re has clients that have between $500 million and $1 billion of uncollectible reinsurance as a result of placing business with carriers that later became insolvent.
To prevent this from happening again, primary companies started taking a more conservative stance with regard to their reinsurance placements. Many insurance companies now demand the highest level of security and long-term viability from their reinsurance markets. To ensure that their business is placed with top-quality markets, many primary companies use reinsurance committees to develop lists of approved reinsurers. Schell notes that these lists have shortened considerably as a result of previous insolvencies and the resulting focus on quality.
The changing cat market
Hurricane Hugo was the largest insured U.S. catastrophe with losses that totaled over $4 billion. That was, until Hurricane Andrew struck in 1992, causing an unprecedented $15.5 billion in damage. That set industry experts fearing another hurricane, one with Andrew's strength, striking a major metropolitan area head on.
The reduction in the availability of catastrophe limits following Hurricane Andrew, and the premium prices put on the limits that were available, led many in the industry to search for ways of addressing the infrequent and very high severity-type exposures. Comments Pat Borowski, division vice president of the National Association of Professional Insurance Agents, "What's clear in terms of market discussions for agents is that somehow, some way, we have to find solutions to the property catastrophe exposure issues. We don't want to see an industry that shies away from finding multiple solutions to this issue, and there isn't a single solution to the problem."
Using Wall Street to underwrite catastrophe exposures is an alternative way of financing catastrophe risks. "In the catastrophe market, we think there will be more use of the capital markets, particularly at the top end for the low frequency, very high severity type of events such as a hurricane the size of Andrew hitting Miami and costing $50 billion," says Sean Mooney, senior vice president at the Insurance Information Institute.
Arkwright Mutual tapped Wall Street in 1996 to address its catastrophe exposure. The company issued $100 million in 30-year contingent surplus notes. The funds it raised through the issuance of these notes have been placed into a trust that can be tapped to cover future catastrophe losses. St. Paul Re also has called on the capital markets to fund its catastrophe writings. According to Schell, "we went to the capital markets at the end of 1996 and raised just under $70 million of capital to write mainly property catastrophe business."
In a joint forum sponsored by leading insurance and reinsurance organizations earlier in the year, Kaj Ahlmann, chairman, president and CEO of Employers Reinsurance, commented on the issues surrounding the transfer of risk to the capital markets. "It's a catchy thing to say we should tap the capital markets but the tools to do this are not easily accessible. And once everything is up and running, who knows how the capital markets will react after the first big catastrophe?" Ahlmann said.
Commenting on the overall availability of catastrophe coverage, Mooney says "typically, the smaller companies, those with 1% to 2% in market share in any given area, can get reinsurance up to about a $500 million event. Getting coverage beyond that is the problem. In these cases, these companies tend to go bare."
But in some instances, Mooney says, insurance companies are in better shape than ever before. A number of companies have raised their reinsurance retention levels and increased the amount of reinsurance they can buy at the high end. He mentions that with Hurricane Andrew, the reason insurance companies became insolvent wasn't because they were using poor quality reinsurance; it was because they just hadn't bought enough reinsurance.
According to St. Paul Re's Schell, the formation of Bermuda companies to write catastrophe-only business was another "mega change" for the cat market. "These companies put all of their capital into writing catastrophe, excess of loss business. They put out lines that were multiples of what traditional reinsurance companies had put out in the past. In 1992, you could be a market leader if you had a $2.5 million in property cat capacity. By 1993, if you didn't have $10 million capacity, you weren't going to be a market leader," adds Schell.
Consolidations likely to continue
Consolidation in the reinsurance segment continued at a brisk pace throughout 1996. While the segment represents approximately 8% of the property/casualty business volume, it experienced a much greater level of consolidation activity that accounted for roughly 40% of the year's mergers and acquisitions (M&As). The largest reinsurance deals of 1996 included Munich Re's $4.04 billion acquisition of American Re, General Re's $1.15 billion purchase of National Re, and the acquisition of Tempest Re for $976 million by ACE Limited.
According to Eric Simpson, senior vice president at the A.M. Best Company, in the mid-1980s there were approximately 120 professional reinsurers. Today, their numbers have dropped to roughly 50. He predicts that there will be further reductions in their numbers, but only to a limited degree because the market needs a certain number of reinsurers.
"One positive impact of reinsurance M&A activity is the ability to write more business in areas with large catastrophe exposures," says Jeff Yates, senior executive vice president of the Independent Insurance Agents of America. "Because they're a larger size, reinsurers can better back up primary companies in catastrophe-prone areas. I think because we've had a couple of years with fairly good results, the reinsurance catastrophe market is improving," he adds.
The Insurance Information Institute's Mooney doesn't believe that the fewer number of reinsurers will make it possible for them to have a free hand in raising their rates, and driving up the cost of insurance. He notes, "While there will be fewer players, it's a very easy business to get into, so other companies will be on the sidelines watching what happens. If the profitability rates begin to look exceptional, we can expect to see other companies wanting to get into the business. These may include primary companies, and members of the capital markets, particularly investment bankers."
Growth in alternative risk transfer mechanisms
The growth of alternative risk transfer (ART) mechanisms was originally fueled by the hard market conditions faced by large insureds in the mid-1980s. Many of the large commercial and governmental risks, facing tremendous increases in the cost of insurance or the inability to obtain coverage, turned to ARTs in order take control of their risk management needs.
The growth in alternative risk transfer mechanisms, such as risk retention groups, captives, and self-insurance, has led to a blurring of the traditional line that separated agents from insurance companies, and insurance companies from reinsurers. "Recent developments seem to be in many areas of the business between what insurance companies used to provide and what reinsurers used to provide," says Schell.
While it used to be that insurance companies distributed their products through agents, and reinsurance companies sold theirs to primary companies, both now provide their products and services directly to large commercial risks and governmental entities through their own alternative risk transfer units. Agents and brokers with clients in this market segment may find themselves dealing with insurers and reinsurers, in order to decide which of the two meets their client's needs. "There is a definite trend towards program or managing general agent (MGA) business. To access it, many reinsurance companies have started providing insurance paper for the book of business, and setting up fronting companies," Schell adds.
General Reinsurance Corporation based in Stamford, Connecticut, is an example of a reinsurer that provides products and services to insurance companies and also within the alternative risk transfer marketplace. Predominantly a direct writer, General Re provides excess insurance and reinsurance to qualified self-insureds through its Genesis Underwriting Management Group. This General Re subsidiary works only with independent agents and brokers and writes business on the paper of its affiliated insurance companies.
Although not always apparent, the reinsurance segment has an impact on insurance agents' business. Staying on top of the major reinsurance issues allows agents to anticipate how these changes might impact the way they serve their clients. *
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