Underwriting Discipline Seen As Critical To Reinsurers' Recovery

"Through the cycle, we intend to earn a certain return throughout, meaning that in one year, you might earn a little less and another year, a little more," said Clement Booth, a member of the board of management for Munich Re in Munich, Germany.

Mr. Booth said Munich Re is determined to walk away from business that falls below technical levels. "So we will not follow the market down–which, to be frank, has been a tendency of reinsurers in the past, especially the global reinsurers," he said.

Mr. Smith noted that support of the need to change underwriting focus starts with the chairman of General Electric "and goes straight down to our underwriters." He added that "market share in this business in a soft market makes no sense."

Mr. Booth noted that in the Jan. 1, 2002 renewal season–when about 60 percent of Munich Res business renews–the company canceled 20 percent of the business up for renewal.

"Its a selection process; a portfolio optimization process," he said. "But we wouldnt want there to be any misunderstanding–if the business is not priced properly well walk away, no matter which market or which product line is involved."

GE ERCs Global P&C Re business unit non-renewed 35 to 40 percent of its entire global book of business this year, affirmed Mr. Smith.

"Weve got to be willing in a soft market to take a business from $4 billion of written premium and shrink to $2.5 to $3 billion, if thats what it takes to maintain underwriting discipline," he explained.

The reason why the company non-renewed such a large chunk of business is that Mr. Smith and his team were convinced that the reinsurer had written a lot of accounts over the last couple of years that didnt have the right risk-return balance.

"Im not afraid to do that. GE is not afraid to let us do that. Thats the mentality weve got to embrace," he said. "The scars that have been left on the industry, including ERC, from poor underwriting in the late 1990s will and should last a long time."

He further noted that policy terms had become very lax during the soft market, and as a result, terms and conditions will have to continue to be refined "to make sure theyre in balance with what the industry should command."

"Well also continue to assess products, and if I think I can make a reasonable return for the risk, well offer it, but Im not obligated to offer any product to anyone where I cant make a return for the risk Im bearing," he said.

Mark Lescault, chief underwriting officer for Swiss Re Americas Division in Armonk, N.Y., said the challenge for his company in every line is to maintain underwriting discipline.

"We have to be disciplined. If we see prices falling to levels that are not supportable, we have to have the discipline to walk away from that business; we owe that to our shareholders," he said.

"With low investment income, it makes it much more difficult for people to consider a cash-flow underwriting model, which in the long run never works," said Mr. Lescault. "You need disciplined underwriting; you have to adequately reflect the impact of investment income, but you also have to focus on the underwriting fundamentals."

"[The pursuit of] market share as opposed to technical underwriting is a failed strategy," according to Donald Watson, former managing director at Standard & Poors in New York. (Mr. Watson was interviewed before he left S&P to go to ACE Asset Management, Inc. in New York, as vice president of enterprise risk management.)

However, Mr. Watson is not convinced about the industrys ability and resolve to change the fundamental way it goes about its business in the long term. "Its been a recurring cycle, and youll see them make the same mistake 10 years from now with a new generation of underwriters," he added.

How long will the hard market last? Mr. Booth did not predict a cyclical downturn any time soon, "unless we are really unable as a market to grasp the seriousness of the last three years."

For the time being, he said, a hard market is here to stay. However, its important to be realistic about the cyclical nature of the industry. The question, he said, is how the industry will behave when rates again become soft.

Mr. Booth did not believe that the new Bermuda start-ups would bring a quick return to soft rating conditions. "These companies are really not the problem. As far as pricing is concerned in the market, if the big four stick to a sound technical basis [for underwriting], then so will the market," he said.

"I cant see any circumstances whereby a Bermudian player will say, well why dont we disrupt this and go out and lose some money. Its just not going to happen," he said.

Given the industrys frail state right now, Mr. Smith predicted that the hard market should last for a number of years. When the market again turns, "I will not be ashamed to let this business shrink significantly in a soft market," he said.

Mr. Booth said Munich Re is very conscious of the impression that the industry "has left with investors in the last two years."

The message is clear, he said, that "we need more strongly to become masters of our destinies than we have in the past," and provide adequate return to shareholders.

Although Mr. Booth admitted that "the proof of the pudding is in the eating," he emphasized that his company is very serious about its long-term commitment to underwriting discipline–now and when the market turns more competitive.

He said the last soft-market cycle lasted at least two years too long, "and we dont intend to make that mistake again. Its not rocket science. Were simply going to have the courage to cancel treaties and connections."

Does this mean the end of the traditional long-term relationships between ceding companies and their reinsurers?

Mr. Booth said relationships fall in two categories–either long-term or opportunistic. He said that Munich Re has changed its handling of long-term partnerships by outlining more specifically "in the beginning what our expectations are of the relationship."

This means that when the returns are not met and Munich Re walks away, "there are no tears shed or blood on the floor because everybody knew at the beginning what the expectation was," he explained.

With opportunistic clients, who buy reinsurance with top security at the best terms each year, "there is no long-term expectation on either side, and we price it accordingly," Mr. Booth added.

Mr. Smith said relationships are still very critical for a select group of GE ERC customers. "There are some customers where relationships mean a tremendous amount, and well be with those customers through thick and thin," he said.

However, he added, "there are others where our customers philosophy is to be opportunistic, and our philosophy must now change and be opportunistic as well. If I can make a return, Ill play. If I cant, I wont."

There are many segments where the company had relationships with clients for many years, he said, adding that they expect the reinsurers to make a reasonable return for that risk. "There is a pay-back mentality if there is a large loss."

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, September 2, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.