If the nautical term best applied to the reinsurance industry last year this time would have been “Steady as she goes,” after the catastrophe that struck the U.S. on Sept. 11, the French term “sauve qui peut” describes its present condition. That phrase can be interpreted as both “abandon ship,” and “every man for himself,” and sums up the reaction to the tragedy. Now comes the hard part, coping with the losses—emotional, personal and financial—and healing an industry that has been forever changed.
Full year statistics have lost their meaning and most forecasts are out the window, but a few certainties are apparent. The costs of covering the losses wrought by the terrorist attacks will be huge. Large well-capitalized companies will nevertheless survive, and ultimately grow stronger. A number of small and mid-sized insurers and reinsurers will have problems; some of them will disappear. The industry will have to make greater efforts to tighten up underwriting standards; the demand for coverage will increase, straining a reduced capacity; rates will rise, and terrorist risk coverage may become virtually unavailable in the private sector at any price.
The U.S. disasters are an event that is unique outside of wartime. The reinsurance industry therefore faces an unprecedented situation. Longtime reinsurance consultant Paul Walther, who heads Reinsurance Directions Inc. in Florida, remarked, “The World Trade Center disaster hit everybody, even the life companies weren’t immune, all the lines were affected.” In that sense, it’s unlike hurricanes or earthquakes, which usually hit property insurers, or air crashes which affect mainly aviation insurers. No sector of the industry remained untouched.
Ironically the attacks came in the middle of the “Reinsurance Rendezvous” in Monte Carlo, and quickly swept aside all other planned discussion topics. Many participants, notably Aon, Marsh and its reinsurance unit Guy Carpenter, lost colleagues in the World Trade Center.
The day before the tragedy, London’s Financial Times had published a survey of the industry that contained some encouraging news, but also warned of deteriorating results. While it noted a general decrease in capacity, leading to increases in premiums, the study also observed that those who supply the capital are becoming increasingly more demanding for greater returns on their investments. They will look even harder after Sept. 11.
The FT also saw an improvement in pricing relative to risks. That conclusion too has been compromised by the WTC disaster. Another phase of the study noted the strength of the Lloyd’s market, with breakeven being reached this year. No one is predicting that now.
Long and short term consequences: challenges ahead
The reinsurance industry still faces some of the same challenges it faced before the attacks, but the changed circumstances now make it even more imperative that it meet them. “It’s going to require quite a lengthy recovery period, but they need to begin satisfying their claims payment obligations now,” Walther observed.
The most visible aspect of the tragedy is the loss estimates. In the few days after the attacks, many reinsurers released preliminary figures, knowing that they’d have to increase them as more definitive numbers were obtained. A few of the latest: Munich Re (American Re)—$1.94 billion; Swiss Re—$1.25 billion; Berkshire Hathaway (General & Cologne Re)—$2.2 billion; Employers Re (GE Capital)—$600 million; Hannover Re—$365 million; Partner Re—$375 to $400 million. Lloyd’s, which waited until Sept. 26 to release its figures, estimates net losses at around $1.91 billion. There are dozens more, and the true total is still unknown. Some estimates have put the overall losses as high as $70 billion.
As Walther indicated, the claims and losses are coming from all sources. According to the New York City Comptroller’s Office, insurance for losses connected with the destruction of the World Trade Center will eventually pay about $17 billion in property losses, $4 billion on life policies and perhaps as much as $18 billion for economic losses.
Business interruption claims may prove the costliest component of the disaster. There are also aviation losses, which could total up to $6 billion, if each of the four hijackings is treated as a separate event, and no legislation is put in force to limit claims. Workers’ compensation for the more than 6,000 victims in the WTC alone will add several billions, as will payments by life insurance companies to the families of victims and to companies on “key man” policies.
Reinsurers have set their estimates as high as they have in recognition of the extent of the losses. While there’s little concern that the larger companies won’t be able to meet claims demands, Lloyd’s loss estimates have raised questions. Its syndicates write around 23 percent of the world’s commercial aviation coverage, and approximately 40 percent of its business is reinsurance. Analysts have indicated that Lloyd’s gross losses could top £7 billion ($10.1 billion), five times the amount of its net loss figure, and have questioned whether it will be able to collect on all of its reinsurance policies.
There are both long-term and short-term consequences for the reinsurance industry. The immediate focus is on liquidity. Companies will have to come up with the amounts necessary to pay claims. This shouldn’t be a problem for industry giants, but it may affect smaller companies in a manner disproportionate to their actual losses. If a company doesn’t have enough cash on hand or liquid investments to pay claims, they have two immediate and equally unpalatable alternatives. They can borrow the money—thereby increasing their debt load—or sell non-liquid assets.
Cashing in assets to pay claims, especially in a depressed market, decreases an insurer’s capacity and thus affects its ability to write new business or renew policies. Therefore, even as rates increase, some companies may not be able to take advantage of them. Increasing the debt load has the same effect, as most of it is secured, and the lenders, not the policyholders, have first claim on it.
“There will be a shakeout,” Walther said. “I’m concerned that a great number of small players in the market will disappear.” On the other hand, he’s sure that the larger companies, the ones who weather the storm, will gain even more marketshare, and will be able to profit from the inevitable premium increases.
He also indicated that part of the problem isn’t just the need for liquidity, but is more structural in nature. “There are many companies that have reinsurance departments, but it isn’t their core business. When they see that they have maybe $1 million in primary exposure, and something like $35 million in reinsurance losses, they’re going to look around and ask themselves ‘should we be doing this?'” The rhetorical answer is “No,” and a number of smaller players will simply pay their losses and get out.
This in turn gives even more leverage to bigger companies, and may make it harder for anyone else to enter the market. “Will it be open to any new players? Will there be sufficient market share to support them?” Walther has his doubts.
Ratings, stock market affect financial conditions
Another difficulty faced by smaller reinsurers, and even some larger ones, are the actions taken by the rating agencies—Standard & Poor’s, A.M. Best, Fitch, and to some extent Moody’s Investors Service. Just putting a company on credit watch negative increases its cost of borrowing. The cost increases again if the company is downgraded. Triple AAA companies don’t have to worry, but S&P has already downgraded Lloyd’s from “A+” to “A” and Zurich from “AA+/Neg” to “AA” and has 18 other insurers on CreditWatch including Hannover Re, Partner Re, PXRE, SCOR, XL Capital, ACE Ltd. and Trenwick Group.
A.M. Best has downgraded Lloyd’s, Trenwick Group, QBE and Copenhagen Re, and is reviewing others. Fitch downgraded Lloyd’s two places from “A+” to “A-,” and noted that “based on Lloyd’s heavy participation in aviation-related risks and high-level catastrophic coverages, Fitch believes that of all the insurance entities within its ratings universe, it is likely that Lloyd’s will experience the greatest financial impact from the terrorist attacks.” It currently has 10 more companies on its Rating Watch Negative list, including ACE, SCOR, XL, and, surprisingly, Swiss Re. In each case Fitch indicated the primary reason for its action was that their current loss estimates “reflect a material percentage of their capital.”
To rebuild that capital, which all companies large and small will need to do in the wake of the disaster, a company can either go to the capital markets and offer shares, or hope that diminished losses and increased premiums will rebuild it over time. Immediately after the attacks, the demand for insurer shares in general and reinsurer shares in particular, nose-dived. Since then there’s been a small recovery, but the threat of a global recession, aggravated by the Sept. 11 attacks, means many companies will avoid issuing new shares. Swiss Re has already indicated that it will probably delay or cancel the $2-billion share offering it had intended to make to fund its purchase of Lincoln National’s reinsurance business.
Reassessment of underwriting standards needed
Unless a company sells out to someone else, or gets out of the reinsurance business, it will need to retrench. Munich Re, in its statement increasing its loss estimates, said: “In addition to the further improvement in rates and conditions that were in any case necessary, Munich Re expects a fundamental reassessment of the risk situation for the renewal of reinsurance treaties that traditionally take place in the last quarter of the year, as the attacks have revealed a previously unimaginable risk potential. This not only affects the U.S. market but also applies worldwide. Primary insurance coverage, as well as terms and conditions, will have to be completely rethought.”
The key phrase is “fundamental reassessment,” and it implies more than just rethinking policy limits and the perils covered. The loss estimates are astronomic not only because the damages are huge, but because the policies cover such a broad range of perils, that weren’t previously considered as potential catastrophe risks. Chief among these is business interruption coverage (IJ, Oct. 15).
This coverage, which is usually written as an adjunct to a basic policy, is open-ended. Given the scope of the WTC tragedy, many primary insurers will end up paying the limits of the policy, which can be quite high. Eventually the reinsurers are going to be asked to reimburse their parts of these payments. Even Munich and Swiss Re admit that they can’t accurately calculate what those losses might eventually add up to.
Walther sees a fundamental problem between the primary insurers’ decision to pay policy limits, and the strictures in most reinsurance treaties that are going to be “at odds with any such decision.” Not only will such disputes delay recoveries, but they will also increase costs if they have to be litigated.
He also saw complications from the “spiral effect,” which he described as the problem that arises from multiple retrocessions of coverage to different reinsurers. Each retrocessionaire essentially thinks he has mitigated his risk by ceding a percentage of coverage to another carrier, who then repeats the process. “In far too many cases, and despite the precautions in place, the loss can come back to the cedants, creating horrendous problems in straightening out who pays and producing loss figures that are several times what’s actually covered.” Walther thinks that Lloyd’s syndicates, which write both primary and secondary insurance, and frequently cede large portions of their exposures, could have a particular problem.
However, Lloyd’s spokesman Adrian Beeby said that although this may have been the case in the past, Lloyd’s has adopted procedures to eliminate it. “By regulation, a certain amount of risks must be reinsured outside of the Lloyd’s market. In addition, Lloyd’s Regulatory Directorate monitors [reinsurance placement] on a transaction-by-transaction basis.” He estimated that “ninety percent of our reinsurance risks are placed outside Lloyd’s with reinsurance companies rated ‘A’ or better.”
A fundamental reassessment must also include a review of underwriting procedures. “Do reinsurance underwriters really know what they’re doing?” asked Walther. He pointed out that Renaissance Re apparently has little or no exposure from the catastrophic events in the U.S. Were they just lucky? Or are they doing something differently than the others?
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Top 20 International Reinsurer Groups
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Ranked by net reinsurance premiums written (U.S. in millions)
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| Company | Net Reinsurance Premiums Written | Adjusted Shareholders’ Funds* | |||||
|
2000
|
1999
|
% Change | 2000 |
1999
|
% Change
|
||
| 1 | Munich Re Group |
15,276.6
|
13,553.9
|
12.7%
|
19,437.0 |
16,517.5
|
17.7%
|
| 2 | Swiss Re Group |
14,478.8
|
12,853.2
|
12.6%
|
14,139.4 |
11,123.8
|
27.1%
|
| 3 | Berkshire Hathaway Reinsurance Group |
8,574.7
|
9,452.5
|
-9.3%
|
40,140.0 |
39,580.0
|
1.4%
|
| 4 | Employers Reinsurance Group |
7,924.0
|
6,921.0
|
14.5%
|
6,025.0 |
5,575.0
|
8.1%
|
| 5 | Hannover Re Group |
4,994.3
|
4,171.9
|
19.7%
|
1,481.5 |
1,240.8
|
19.4%
|
| 6 | Gerling Global Reinsurance Group |
4,117.0
|
3,921.9
|
5.0%
|
1,388.4 |
1,333.9
|
4.1%
|
| 7 | Llloyd’s of London |
3,952.9
|
3,807.8
|
3.8%
|
8,268.4 |
9,093.1
|
-9.1%
|
| 8 | Allianz Reinsurance Group |
3,726.5
|
3,295.9
|
13.1%
|
53,414.0 |
45,376.3
|
17.7%
|
| 9 | SCOR |
2,809.8
|
2,718.1
|
3.4%
|
1,267.4 |
1,241.1
|
2.1%
|
| 10 | Zurich Re |
2,485.0
|
1,878.0
|
32.3%
|
1,541.6 |
1,503.8
|
2.5%
|
| 11 | Transatlantic Holdings, Inc. |
1,658.6
|
1,498.5
|
10.7%
|
1,856.4 |
1,642.5
|
13.0%
|
| 12 | AXA Reinsurance Group** |
1,424.7
|
1,137.6
|
25.2%
|
1,628.2 |
1,268.0
|
28.4%
|
| 13 | PartnerRe Ltd. |
1,380.3
|
1,326.4
|
4.1%
|
2,086.0 |
1,840.7
|
13.3%
|
| 14 | St. Paul Re |
1,251.5
|
1,056.4
|
18.5%
|
7,178.0 |
6,448.0
|
11.3%
|
| 15 | Everest Re Group Ltd. |
1,218.9
|
1,095.6
|
11.3%
|
1,583.4 |
1,327.5
|
19.3%
|
| 16 | XL Re Ltd. |
1,022.2
|
970.0
|
5.4%
|
5,573.7 |
5,577.1
|
-0.1%
|
| 17 | Korean Re |
977.5
|
755.5
|
29.4%
|
323.4 |
262.1
|
23.4%
|
| 18 | CNA Re |
951.0
|
1,275.0
|
-25.4%
|
8,387.0 |
8,679.0
|
-3.4%
|
| 19 | Toa Reinsurance Co. Ltd. |
942.4
|
1,101.8
|
-14.5%
|
2,204.0 |
2,933.3
|
24.9%
|
| 20 | Hartford Re Group |
825.9
|
703.0
|
17.5%
|
5,668.0 |
6,897.8
|
17.8%
|
|
* Reported adjusted shareholder’s funds include both primary and reinsurance operations.
** All figures except net reinsurance premiums written include primary and reinsurance business. Source: Standard & Poor’s |
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Underwriting standards and capacity
Actually, RenRe estimates its net exposure from Sept. 11 to be at least $50 million, but considering that it is uniquely a property catastrophe reinsurer, that figure is surprisingly low, and it does not appear to have been luck. RenRe offers a good example of how a reinsurer can be successful, even in difficult times.
It’s known for using some of the most sophisticated risk modeling techniques in the industry. When Deutsche Bank Alex Brown initiated coverage on its stock last June they pointed out that one of the factors giving the stock a “BUY” recommendation was its “sophisticated modeling that gives a distinct underwriting advantage.”
According to Martin Merritt, financial VP, “We try to use [modeling capabilities] for every single risk we write, and we get as many details from the broker as we can.” He estimated that RenRe has spent more than $20 million to develop its models, and employs eight to 10 people on a full-time basis to update them and construct new ones.
Merritt explained that every model has a bias, thus “using only one model works against you; by using more than one, you can reduce this effect.”
RenRe’s models include an analysis of the current type of risk, and enable the underwriters to spread out their risks. It also explains why the company was able to limit its losses from Sept. 11.
At the recently concluded Bermuda Angle Conference, it stressed four factors: “1) We were significantly under-weighted in large commercial primary cat accounts; 2) our assumed retro book is under-weighted in U.S. and worldwide covers; 3) we wrote limited per risk excess business due to correlation concerns; 4) not exposed to certain key lines: aviation, workers’ compensation, life, general liability, event cancellation, etc.”
That kind of care enables RenRe to do one thing very well—make money. Its return on equity in 2000 was 20 percent. Merritt explained that by committing the minimum amount of capital required to cover each risk, it was able to utilize its capital more efficiently, which in turn meant that there was more capital available, which generated higher returns.
Capital availability is now more critical than ever. Walther observed that despite the anticipated premium raises, and the increased demand for coverage, “there hasn’t been any great interest on the part of the capital markets.”
Investment banks are used to financial risks, but not to those associated with reinsurance; therefore, most of the new activity has come from within the industry.
RenRe was quick to recognize opportunity. It sold $233 million worth of its shares, from a shelf registration of $400 million, increased the capitalization of Glencoe Insurance, its commercial property subsidiary, by $100 million, and announced that it was forming Da Vinci Re in partnership with State Farm with an initial capitalization of $500 million.
Marsh & McLennan’s MMC Capital is setting up AXIS Specialty Ltd. in Bermuda, capitalized at $1 billion. CEO J.W. Greenberg said in a written statement, “MMC is sponsoring the formation of AXIS Specialty in response to demand for reinsurance and insurance capacity at a time when it is most needed in the marketplace.”
Aon has announced similar plans, and a number of other insurers are looking to establish new companies with new capacity, principally in Bermuda.
The necessity to show senior managers and investors that reinsurance underwriters know what they’re doing directly affects a company’s ability to raise capital, and by definition increase its capacity. “They’re really going to need to convince people on this,” Walther said. This is especially true when other investments are available.
The reinsurance market, especially Lloyd’s, will now be measured by its ability to produce returns commensurate with competing investment opportunities. Walther thinks it’s possible that a lot of the corporate capital that has flowed into Lloyd’s may “decide to leave.” Should capital providers take their funds elsewhere it would severely strain not only Lloyd’s, but the entire reinsurance system at a time when it appears to be particularly vulnerable.
|
6/30/01 Results for the Top 25 Reinsurers based on Year End 2000
Net Premium Written (000 omitted) |
||||||||
| 12/31/00 | 6/30/01 | 6/30/01 | 6/30/01 | 6/30/01 | 6/30/01 |
6/30/01
|
||
| YTD | YTD | YTD | YTD |
YTD
|
||||
| NAIC Code | Company Name | Net Premium Written | Admitted Assets | Net Income | Net Premium Written | Loss & LAE Ratio |
Expense Ratio |
Combined Ratio
|
| 22039 | General Reinsurance Corp | 3,260,803 | 16,532,475 | -81,467 | 1,724,195 | 92.98% | 26.47% |
119.45%
|
| 10227 | American Reinsurance Co | 3,165,479 | 10,761,797 | 73,630 | 1,730,404 | 76.44% | 30.84% |
107.28%
|
| 39845 | Employers Reinsurance Corp | 2,227,138 | 11,413,448 | 143,602 | 1,261,531 | 78.46% | 31.05% |
109.51%
|
| 25364 | Swiss Reinsurance America Corp | 1,758,729 | 9,375,077 | 68,293 | 832,061 | 98.99% | 28.11% |
127.10%
|
| 19453 | Transatlantic Reinsurance Co | 1,456,678 | 4,517,732 | 68,877 | 798,555 | 74.09% | 27.39% |
101.48%
|
| 26921 | Everest Reinsurance Company | 1,211,773 | 5,054,807 | 52,460 | 785,055 | 74.20% | 30.70% |
104.90%
|
| 22969 | GE Reinsurance Corp | 1,096,434 | 2,810,809 | 22,798 | 564,378 | 78.48% | 30.14% |
108.62%
|
| 10873 | Farmers Reinsurance Company | 1,000,000 | 837,220 | 20,048 | 300,000 | 70.92% | 26.62% |
97.53%
|
| 39136 | Zurich Reinsurance North America | 959,759 | 3,822,633 | 57,020 | 548,965 | 68.79% | 33.37% |
102.17%
|
| 21032 | Gerling Global Reins Corp of America | 870,624 | 2,189,954 | -21,387 | 438,549 | 83.39% | 33.12% |
116.51%
|
| 23680 | Odyssey America Reins Co. | 515,306 | 2,317,195 | 61,387 | 373,554 | 68.88% | 31.90% |
100.77%
|
| 30058 | SCOR Reinsurance Co | 414,105 | 1,783,471 | -5,165 | 315,529 | 75.56% | 31.71% |
107.26%
|
| 38636 | Partner Reinsurance Co of the US | 369,726 | 992,912 | -25,274 | 274,047 | 81.12% | 29.51% |
110.63%
|
| 38776 | Folksamerica Reinsurance Co | 332,691 | 1,689,134 | 9,150 | 228,912 | 86.65% | 29.84% |
116.49%
|
| 22314 | Underwriters Reinsurance Co | 308,389 | Data Not Available | |||||
| 36552 | AXA Corp Solutions Reins Co | 275,768 | 953,479 | -21,400 | 184,937 | 72.52% | 37.98% |
110.49%
|
| 14117 | Grinnell Mutual Reinsurance Co | 216,325 | 420,739 | 1,063 | 131,445 | 75.96% | 28.48% |
104.44%
|
| 39322 | Sorema North America Reinsurance Co | 196,004 | 588,898 | -25,506 | 101,655 | 83.02% | 41.81% |
124.83%
|
| 34894 | Trenwick American Reinsurance Corp | 187,354 | 794,879 | -17,916 | 126,059 | 91.04% | 34.84% |
125.88%
|
| 20583 | XL Reins America Inc | 181,648 | 2,022,277 | 43,243 | 113,717 | 64.66% | 6.86% |
71.51%
|
| 33499 | Dorinco Reinsurance Co | 181,330 | 1,305,220 | 3,807 | 132,342 | 96.82% | 18.43% |
115.25%
|
| 10219 | QBE Reins Corp | 168,649 | 521,977 | -3,145 | 117,121 | 74.67% | 32.15% |
106.82%
|
| 42439 | TOA-Re Reinsurance Co of America | 157,313 | Data Not Available | |||||
| 44440 | Discover Reinsurance Company | 95,689 | 530,837 | 4,617 | 62,189 | 84.53% | 2.83 |
87.37%
|
| 29807 | PXRE Reinsurance Company |
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