Dearth Amidst Plenty – Reinsurers Send Mixed Signals

Is the glass half-full, or half-empty?

The classic example of identical facts dictating opposite conclusions, depending on whether you’re an optimist or a pessimist, defines the current picture in the reinsurance industry, even if it is admittedly a bit more complex.

On the positive side many insurers and reinsurers posted good results in 2002, and did even better in the first quarter of 2003. Bermuda-based companies, including those formed after Sept. 11, turned in particularly stellar performances (See box Page 38). The results should be considered in the light of two significant factors, however: 1) A lot of 9/11 losses were taken in the first quarter of 2002, and 2) many of the new companies did not begin writing a lot of business until later in the year.

While Bermuda basks in plenty, many older companies, starting with Munich Re and Swiss Re, the world’s first and second largest reinsurers, are coping with difficulties the island’s insurers don’t face. In the U.S., General & Cologne Re and National Indemnity have bounced back, once again earning money for Berkshire Hathaway. While in the U.K., Lloyd’s just posted its first net profit in six years and its best results ever.

Then there are the companies with more serious problems. No one has heard much from General Electric recently about what it wants to do with its global reinsurance units but, following a $1.4 billion loss at ERC last year, GE is by all reports still trying to find a buyer. Germany’s Gerling, the world’s seventh largest reinsurer as recently as 2001, has left the market entirely. France’s SCOR, the new number seven, appears to be on the way to recovery following serious losses. It posted net after tax income of 31 million ($36.5 million) in the first quarter of 2003.

There are also a number of companies who have gotten entirely out of reinsurance. The biggest include: Zurich, who spun-off of its reinsurance divisions into Converium in 2001; the St. Paul, who formed Platinum Underwriters with its reinsurance operations, and took it public in 2002, and The Hartford, who just announced that it was selling its reinsurance activities to Endurance Specialty. If the business is doing so great why are so many companies having problems, or getting out of it?

The answers are complex, but Paul Walther, who heads Reinsurance Directions in Heathrow Fla., observed that “the longer a company has been in the business the bigger challenges they seem to face. Many of them are facing the legacy of the past, the skeletons in the closet.” Even though short-term results are now more favorable than they’ve been in years, a lot of companies have had to increase reserves, particularly for asbestos-related liabilities, on top of declines in the value of their investments-the infamous “double whammy.”

“In some cases,” said Walther, “this has made them unwilling to go forward.” Speaking of companies such as the St. Paul and The Hartford, who are not primarily reinsurers, Walther explained that they’ve had “to reappraise how they play the game, and in many cases; they’ve decided to concentrate on their core business;” that means exiting the reinsurance business. While they still retain the responsibility for older claims, they have limited their future liabilities, thus reducing the level of uncertainty.

Over a year ago an article in the Insurance Journal described asbestos as a “shroud over the industry.” It still is. Despite current proposals to remove the compensation claims from the courts by setting up a trust fund to pay those who are really ill, a lot of companies have had to repeatedly increase reserves to deal with potential claims. Walther worries that the numbers don’t add up. “There’s an existing gap between what the insurers have said they might have to pay and what the reinsurance community has acknowledged.” They are reluctant to admit the depth of the problem, because it would mean setting aside more reserves. As a result, companies whose core business is not reinsurance are asking themselves, “Do we want to do this any more?” Frequently the answer is “No.” In addition, the downturn in the world’s equity markets has foreclosed, at least for the time being, the margin of safety they provided insurers. “They no longer have the ability to make up for past losses through investments, “said Walther, and consequently “they’re worried about it in terms of capacity.” Every dollar stashed away as a reserve against claims means there’s one less dollar that can be used to generate future business.

The situation helps to explain the growth and success of the Bermuda companies. An insurer or reinsurer with a fresh balance sheet, and strong capitalization is in a much better position to seek new, and higher quality, business, than a company that’s faced with a number of long-tail exposures like asbestos.

Bear in mind that the “New” Bermuda companies are not strangers to the industry. For the most part they are long-time players and/or very sophisticated investors. They weren’t set up by people sitting around after 9/11 who suddenly decided to start a reinsurance company.” RenaissanceRe, possibly the world’s savviest reinsurer, and State Farm set up the first one, DaVinci Re. It was closely followed by Allied World-AIG, Chubb and Goldman Sachs; Axis Specialty-Marsh, Credit Suisse, J.P. Morgan and others; Endurance-Aon and Zurich; Montpelier Re-White Mountains and Benfield, to name some of the biggest ones.

Nor are the people who manage them exactly novices. Without exception they’re experienced professionals: Kenneth LeStrange at Endurance; Michael Morrison at Allied World; John Charman at AXIS, and Anthony Taylor, a former Lloyd’s MGA, at Montpelier. With all those years of experience in the reinsurance industry behind them and large amounts of capital, it’s not terribly surprising that they’ve managed to make money.

In addition to the newcomers many of Bermuda’s “older” companies, led by ACE Limited and XL Capital, and including RenRe, Partner Re, PXRE, Max Re and others, also bear less of a burden from past claims than older companies do. This gives them more flexibility to pick and choose what types of business they will write, while it limits the flexibility of their competitors.

The best example is RenRe, which historically has written only Property Catastrophe Reinsurance, and has seen its earnings increase quarter after quarter, year after year. How far into the future can that trend continue?

In affirming the operating company’s ‘A+’ rating and the holding company’s ‘A-‘ rating, Standard & Poor’s credit analyst Karole Dill Barkley observed that, “With the passage of time and the emergence of significant underwriting, capital, and investment difficulties among many of the sector participants, RNR’s underwriting track record of strong and consistent earnings is at present unparalleled. The earnings strength is bolstered by very strong cash flow, very strong financial flexibility, and a growing stream of underwriting risk-free fee income.”

Compare that with the situation at Swiss Re, which, as expected, posted a net loss of SwF 91 million ($69.3 million) in 2002, and consequently reduced its dividend payment to one Swiss Franc, about 76 cents. The company, hit by the “double whammy,” had to increase reserves as investment revenues and equity values were falling. Even though Swiss Re’s gross premium volume rose by 15 percent last year, to SwF 29.1 billion ($22.157 billion), “due in large part to considerable improvements in the operational performance of core business activities,” according to Peter Forstmoser, the chairman of the Board of Directors, the company still posted a net loss, despite the “favorable conditions in the reinsurance industry.”

In a telephone interview shortly after Sept. 11 Walther said, “There’ll be a shakeout. I’m concerned that a great number of small players in the market will disappear.” On the other hand he predicted that the larger companies, the ones who weather the storm, will gain even more market share, and will be able to profit from the inevitable premium increases.

That is essentially what has been happening. The runoffs, spin-offs and sell-offs since the end of 2001 have left the market with fewer, but larger, players. If it weren’t for the new capital that has come into the market, mainly in London and Bermuda, the pressure on capacity would be greater than it actually is. Axis took over Kemper’s D&O lines; Endurance acquired La Salle Re’s property catastrophe reinsurance business, and is set to take over the Hartford’s reinsurance business as well.

Walther still sees problems on the horizon, however. “Clearly the reinsurance business deals with uncertainty,” he said, “but we’re now going through more uncertain times than ever before.” Firstly, “How much staying power will they [new investors and companies] have? They’re going through good times now, but what happens when there are a couple of big ‘cats’ [catastrophe losses] in one year?” Losses from a major hurricane haven’t occurred in over three years, but they will. While the recent tornadoes caused heavy losses, even more catastrophic events could happen at any time, as the recent earthquakes in Algeria and Japan have reminded us.

Secondly, there’s the unknown, and largely unknowable, risk posed by resurgent terrorism. “I don’t know what impact TRIA [the Terrorist Risk Insurance Act] will have,” he said, “but we seem to be dealing with a whole new definition of risk.” The new risks that private sector insurers are being asked to cover relate to the third potential problem. What happens if the money runs out?

“Reinsurance operates by the law of large numbers,” said Walther. “You take in a large amount of money from many sources to cover a few actual risk bearers, but there’s a limit as to how much they [reinsurers] can hedge their exposures. If more money is going out than is coming in, eventually they won’t be able to cover the risks.”

If that happens, primary insurers have to cut back on the risks they accept, as they can’t reinsure them. “Insurance is a vital industry,” said Walther; “It does the best it can, but I worry whether the private sector will be able to continue to do what it’s supposed to do if it doesn’t have enough capacity.”

The concentration of more and more capital in the hands of fewer and fewer players is a related concern. He feels this could ultimately destroy the diversity that allows the industry to cover a multitude of risks. The specter of increasing numbers of smaller players leaving the market, while largely undocumented, poses exactly that kind of dilemma down the line, despite all the good recent economic results.

Topics Catastrophe Carriers Profit Loss Reinsurance