Navigating a Shrinking Market

Experts predict OSFI's recent repeal on limits won't significantly change the reinsurance landscape

Reinsurers across the nation are facing a steadily shrinking market caused in part by the consolidation of primary companies, as well as structural changes in reinsurance programs as ceding companies switch from proportional to non-proportional reinsurance contracts. However, a shrinking market and a shifting regulatory landscape around reinsurance are unlikely to have a major impact on pricing in the primary market, according to industry experts.

Primary companies today have more excess capital, allowing them to retain more risk in-house instead of flowing those risks through reinsurers. The formation of captives, reciprocals and self-retention groups is further reducing the amount that companies are spending on reinsurance. For example, Healthcare Insurance Reciprocal of Canada (HIROC) provides an alternative for healthcare organizations to obtain liability insurance, and the reciprocal wrote about $125 million in gross premiums in 2008, according to the company’s latest statistics.

The shrinking reinsurance market is leading to an overall decline in gross written premiums (see sidebar below: Decade in Review). The Reinsurance Research Council (RRC) reports that premiums written by member companies in 2009 were approximately $2.18 billion. However, this is a sharp decrease from the all-time highs of the early 2000s. Gross written premiums in 2002 were $2.96 billion, in 2003 were $3.14 billion and in 2004 were $2.66 billion, according to the RRC.

Limit Repeals
The upcoming repeal of the 25% limit on unlicensed reinsurance, effective June 2011, may help accelerate the Canadian market’s steady decline as there may not be as much business written in Canada. At the same time, the repeal of the 75% limit on overall reinsurance opens the door for Canadian companies to cede more risk to reinsurers.

But according to some reinsurers and intermediaries, the repeals won’t be significant enough to change the landscape of the Canadian market.

“Companies will continue to work with local licensed reinsurers as there is more comfort around these relationships,” says Mike Mulville, executive vice president, Towers Watson. “Unlicensed markets will be used but in accordance with federal regulations.”

Sharon Ludlow, president and CEO of Swiss Re in Canada agrees, stating that because regulators still require offshore or unlicensed reinsurers to have a certain amount of collateral before taking on a contract, there won’t be a rush for ceding companies to purchase offshore reinsurance.

“Collateral is not cheap or free to them,” she says. “They won’t want to put up a lot of collateral to write that business. Because the collateral requirement is still there, I don’t see it changing the entire landscape.”

And will the repeal have any impact on pricing and terms in the primary market? Mulville says it could put more pressure on rates in certain lines of business if local companies choose to front for foreign companies that have expertise in niche areas.

Ludlow explains further that there may be one-off situations with price increases on products in primary insurance if a company chooses an unlicensed reinsurer. ‘You can see the potential for a knock on the primary company’s pricing. If they’re paying more for reinsurance [using an offshore reinsurer], they will want to pass that cost on. But again, I don’t think we’re changing the landscape so I don’t see a pricing issue in the near term.”

Market Shakers
Experts agree that it will take a large catastrophic event to have a major impact on the market.

“Recent publications have indicated that it would take a $74 billion catastrophic event,” says Henry Klecan, president and CEO of SCOR Reinsurance Company (Canada). “Large [catastrophes] can change things very quickly.”

He adds that there is significant capacity in most lines, and even if there were a large catastrophic event, this wouldn’t change. A number of reinsurers are buying back their own shares and this might indicate they don’t know what to do with the excess capital they have, he says. “If we maintain a status quo, we should not see any depreciation in the capacity.”

The flood and wind losses in Western Canada and storm losses in Eastern Canada have not triggered major pricing changes. Mulville says this is because many companies are keeping larger net retentions and retaining more loss. In addition, reinsurers have an appetite for catastrophe business so the market is competitive, which is keeping pricing down for now.

Mulville also points out the irony that losses experienced in the United States are historically more influential in our market than those in Canada.

“If the US has a bad hurricane season, then as a market Canada sees primary pricing increase. Canadian elemental losses do not seem to move pricing as much as elemental losses in the US do.”

One factor that could impact pricing and rates in the primary market is the launch of flood insurance on personal lines. Overland flooding is not covered in Canadian homeowner policies, and according to Walter J. Williamson, senior vice president and managing director for Canada at Beach and Associates Ltd., there’s a push in the industry to work together and form a water damage policy.

Ludlow adds that a flood insurance policy would address current consumer misinformation about flood coverage.

“In three to five years, as flood events happen in different regions that are not insurable, the consumer will realize this,” she says. “It will become the insurers’ and the politicians’ nightmare as they try to address it on a reactionary basis.”

A recent Swiss Re and Institute for Catastrophic Loss Reduction (ICLR) study uses models that work in other regions of the world as examples of how to make this product available in Canada. It requires the government to increase flood risk assessment and public relief programs that do not conflict with flood insurance. “This is so we’re not simply reacting and then rates increase. Instead, we’re building it into a homeowner’s coverage,” says Ludlow.

Reinsurance Intermediaries
Anyone in a business that is faced with a mature or shrinking market has to continue to look for new opportunities and reinsurance intermediaries are no different.

According to Klecan, reinsurance brokers need to offer more services and products. Recently, he says, they’ve added actuarial services that are necessary in today’s market.

Guy Carpenter (click here to see the cover story from the March 2011 issue) is one example of a reinsurance intermediary that evaluated the market and found a gap that needed to be filled, according to Ludlow. “Five to seven years ago, agriculture insurance and reinsurance in Canada were not a gross target. But now they’ve increased that business substantially in both insurance and reinsurance by coming up with products that are appropriate for grain producers.”

She adds that it’s all about researching the Canadian market, and creating products that are needed or lacking.

Beach and Associates, for example, has made its reputation in the market by delivering services others can’t, according to Williamson. “It’s about thinking outside the box. We believe in being close to our customers and knowing what their needs are.”

Meanwhile, Towers Watson is investing in more financial and catastrophe modelling capabilities. Mulville says the company’s recent acquisition of EMB, a P&C insurance consulting and software company, is a good example. EMB can assist the firm in providing software for pricing, financial modelling, reserving and marketing analysis, adds Mulville.

In order to compete in the market, Towers Watson also bundles services with clients and prospects.

“Given the diversity of products and services offered within our group, sometimes bundling is a better way to assist companies, rather than have a piecemeal approach to things,” says Mulville.

Primary Concerns
For the independent broker channel, the focus should be on reinsurance education, say the experts.

“They have to be aware of the issues,” says Williamson. “The markets they’re dealing with are taking on more risk, and they should be listening and asking questions. In protecting the ultimate insured, the primary broker has to work closely with its markets [insurers], ascertain if they are sound and willing to maintain the right coverage at a reasonable price.”

Ludlow agrees. “A primary broker should have enough knowledge about the ceding company to know, do they have a good risk management program and do they have reinsurers behind it? Is it subject to a rigorous and disciplined stress test, and is that ceding company comfortable with their capital level that they can absorb losses up to their retention?”

Also, Mulville says that an independent broker should ask senior management of an insurance company how much catastrophe protection they are buying and how much more they will buy to meet OSFI recommendations (see sidebar below: Due Diligence Required). Insurers have until 2022 to purchase protection commensurate with a probable maximum loss (PML) that complies with OSFI’s mandate of protecting to the 500-year event level, he says.

“Depending upon how much catastrophe protection a company has now will influence their reinsurance spend for the future, which will have to be accounted for somehow, either by absorbing the net costs or passing them along to their policyholders.”


Decade in Review

Year    Canadian reinsurance gross written premiums (in billions)
2001    $2.22
2002    $2.96
2003    $3.14
2004    $2.66
2005    $2.11
2006    $2.17
2007    $2.20
2008    $1.91
2009    $2.18

Source: The Reinsurance Research Council


Due Diligence Required

What will be the likely impact of the implementation of OSFI’s B3 guidelines on reinsurance for financially regulated insurers?

“It’s going to have an expensive infrastructural change. Each of the companies will have to assume a risk management process and in turn have the board of directors involved in the process and in the securitization of the reinsurance, especially from the unlicensed market to make sure they are the preferred creditor on these accounts. It will bring a whole new regime on what the industry has seen now.”
–Henry Klecan, president and CEO, SCOR Reinsurance Company (Canada)

“There will be more due diligence, both from the ceding company and the reinsurer. It will bring some rigour, discipline and may be time-consuming, but overall it’s a fairly healthy thing that many companies are already doing. It is simply formalizing it.”
–Sharon Ludlow, president and CEO of Swiss Re in Canada

“More transparency regarding reinsurance-buying practices and reinsurers supporting the programs, which is a good thing for all parties (from the regulators through to the primary insurance brokers). Also, reinsurance contract uniformity dealing with Insolvency and Offset provisions will reduce the probability of disputed claims when companies are being wound up.”
–Mike Mulville, executive vice president, Towers Watson

To read more coverage of reinsurance from the March 2011 issue, click here.


Copyright 2011 Rogers Publishing Ltd. This article first appeared in the March 2011 edition of Canadian Insurance Top Broker magazine.

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