Lagging Reserve Effects, Changing Buyer DemandsChallenge Reinsurers

The property-casualty reinsurance sector has made quite acomeback in the past year, but theres no time to stop and smell theroses for these reinsurers stuck in a fast-changing marketplace,reinsurance company executives say.

While the combined results of U.S. p-c reinsurers, as reportedby the Reinsurance Association of America last month, swung back toprofit during the first nine months of 2003 compared to one yearearlier–and their combined ratio improved some 15 points to getaround the break-even 100 point–reinsurance executives in thetrenches are the first ones to acknowledge that their companiesmust overcome any number of challenges in 2004 to succeed andthrive.

These include adapting to a shifting marketplace, creating andmaintaining underwriting profit, and dealing with potential reservedeficiencies–to succeed and thrive.

Another issue cited by reinsurance executives is that eventhough primary companies are enjoying a better rate adequacy, thatdoesnt always make it to the reinsurance sector since many primaryinsurers are choosing to keep the business net and buy lessreinsurance.

“I believe the biggest challenge is the rapidly changingenvironment, said William Jewett, chief operating officer at theWhite Plains, N.Y.-based Endurance Reinsurance Corp. of America,part of Endurance Specialty Holdings in Bermuda. “The landscapewill be continuously changing,” he warned.

“The challenge for all reinsurers is to be able to read themarket quickly, be decisive, and react and move quickly, since thepace of change is accelerating.”

Specifically, reinsurers have to be perceptive to themarketplace and be able to identify opportunities, whether on theindividual-transaction basis or the business-segment,marketplace-opportunity basis, Mr. Jewett advised. “In thismarketplace, as we all know, some segments are more profitable thanothers, but the pattern could change over the course of a year. Soyou have to know when to participate, when to target and focus, andwhen to sit back.”

There is a sense among reinsurers that there will be a continueddislocation in the marketplace over the next 12 months, and thatwithin that shifting landscape, reinsurers will see challenges aswell as opportunities, depending on how well-prepared they are.

In 2003, a number of institutions exited the reinsurancebusiness, among them established players like Chicago-based CNA andPMA Capital in Philadelphia. And with some other large U.S. playersalso withdrawing from unprofitable lines in this sector, businesseshave been shifting among U.S. reinsurers as well as to offshorecompanies.

“There continue to be companies that withdraw from thereinsurance marketplace, either voluntarily or involuntarily, as aresult of ratings actions that basically made them uncompetitive,”observed Jack Snyder, chief marketing officer at American Re Corp.in Princeton, N.J. “And based on how ratings agencies are posturingthemselves, it appears that there will be more downgrades, and,yes, there will be more consolidations in 2004.”

One example of shifting business in the marketplace can be seenat Endurance Reinsurance, which bought most of Hartford FinancialServices Groups reinsurance unit last May. This unit, which wascalled HartRe, wrote more than $700 million in treaty andfacultative reinsurance in 2002.

Mr. Jewett said that in the past 12 months, some shiftingbusinesses in the reinsurance sector have been picked up by U.S.onshore companies that are subsidiaries of offshore companies.“There will be more changes and shuffling within the industry thisyear,” he predicted.

Some reinsurance experts are also worried that despitesignificant reserve additions made by reinsurers in recent yearsthere may still be a potential for further reserve deficiencies inthe industry, and even the possibility of a lagging effect at workon reserves.

Last year, some of the reinsurers that announced reserveadditions included SCOR U.S. Group/SCOR Reinsurance Company, partof Paris-based SCOR and XL Reinsurance, part of Bermuda-based XLCapital.

Rick Smith, president and chief executive officer at the globalproperty and casualty unit for Employers Reinsurance Corp. inOverland Park, Kan., told National Underwriter that hiscompany has faced some adverse developments in the past few yearsand has strengthened its balance sheet.

“Across ERC, we have strengthened reserves in the past few yearsby over $6 billion across all major lines,” Mr. Smith said. “ERChas scoured every reserve segment that it has, including asbestosand environmental, and strengthened its reserves. We feel that wehave done what is right, and we are in a great position now tocapitalize on the market going forward.”

“Most ratings agencies have negative outlooks on the reinsurancesector, due in part to the potential future emergence of reserveinadequacies,” Mr. Snyder observed. In theory, he acknowledged,there really may be a lagging effect at work here.

“The further you get away from the original pricing andunderwriting of the business, the more you introduce delays in theavailability of information. You also get information that is notonly delayed, but its quality may not be as good as you want,” headded.

Due to this business model and how the information is gatheredand transferred from primary companies to reinsurers, “thereinsurance sector does tend to lag in reserving actions taken byprimary companies,” Mr. Snyder said.

There is also a growing difference of opinions among reinsurerson how conservative they should be with respect to loss-reserveadequacy. “There are emerging differences on how companies reserveon average and what they are carrying in terms of loss ratios forcertain accident years of business, mainly in the problematicaccident years of the 1997-to-2001 period,” Mr. Snyder noted.

This is partly the reason why, he said, there is a heightenedscrutiny by Wall Street and ratings agencies, trying to forecastwhere the next big reserve charges might take place in thereinsurance sector.

Furthermore, these various challenges are compounded by the factthat the reinsurance sectors underlying client–the primaryinsurance sector–is continuing to keep more business net.

Mr. Snyder observed that even though the primary industry isenjoying better rate adequacy in most lines, “that doesnt alwaystranslate into business flowing into the reinsurance sector.” Manyprimary insurers, especially the ones that have the financialwherewithal to do so, are electing to keep the business net, hesaid.

“Its not that they dont buy reinsurance anymore, but they tendto buy less, and they buy more excess, higher layers of limits toprotect themselves. But at the same time, these are also the mostvolatile layers of business–they typically dont have a lot of cededpremiums associated with them.”

This represents a significant trend in the marketplace–theprimary marketplace appears to be growing faster than thereinsurance sector, he said.

“Thats because less businesses are being ceded to thereinsurance marketplace. Some businesses are being converted from aproportional or quota-share type of reinsurance to anexcess-of-loss [basis], which involves less ceded premiums,” Mr.Snyder said.

“So we have all these challenges to deal with in the reinsurancesector, and buyers are tending to buy less,” he observed. On top ofthat, “we also have to be much more disciplined with maintaining anunderwriting profit,” Mr. Snyder noted, explaining that the ongoinglow-interest-rate environment doesnt allow reinsurers to make theirmargin from the management of investment assets at the end of theday.

“The business is more capital intensive; its becoming morevolatile and there is a greater correlation of risks across classesof business. And there are the historically low interest rates,”Mr. Snyder said as he went down the list of challenges. “So thereis an urgent need to generate an underwriting profit to beeconomically healthy and viable in this marketplace.”

Thankfully, reinsurers staying in the business are starting torealize the need for more disciplined underwriting. “It wasnt toolong ago that reinsurers would throw around combined-ratio targetsof something like 105s, 103s, 107s,” Mr. Snyder recalled. Butbeginning in 2002, reinsurers started to understand that theircombined-ratio targets needed to be below 100.

“I think the reinsurance industrys combined ratio, despite morereserve strengthening that remains to be seen, should furtherimprove in 2004,” said Mr. Snyder, whose company, American Re, hasa general portfolio target of a mid-90s combined ratio.

Another forthcoming issue in the reinsurance sector is theterrorism reinsurance and the federal Terrorism Risk Insurance Act,noted Guy Carpenter & Company Inc., a reinsurance brokerageunit of New York-based Marsh & McLennan Companies. “We havebeen seeing more activities here. As TRIA retention increases, andas TRIA expires on 2005, insurers are looking for ways to managethat through reinsurance,” said Peter Zaffino, managing director atGuy Carpenter. “So we are exploring a lot of opportunities withreinsurers in that segment.”

Reproduced from National Underwriter Property &Casualty/Risk & Benefits Management Edition, January 2, 2004.Copyright 2004 by The National Underwriter Company in the serialpublication. All rights reserved.Copyright in this article as anindependent work may be held by the author.