Beset by the global recession and a seemingly never-ending soft market, Tim Evershed reviews the state of and prospects for casualty lines.
The effects of last year's financial meltdown continue to be felt in many sectors. Although casualty (re)insurers were spared the near-collapse that afflicted the banking sector, they have been far from immune.
Non-life carriers may have largely avoided investments in mortgage-backed securities but decreasing asset values and falling bond ratings have brought tribulations of their own.
Casualty (re)insurers are particularly at risk from recessionary factors, including an expected rise in corporate insolvencies, mounting unemployment and increased litigation.
"The economy, the economy the economy," says John Bender - president at Allied World reinsurance - rather succinctly when asked what are the key issues facing the casualty market. It is a sentiment that strikes a chord with many.
"The impact of the recession is the major factor facing the casualty sector. In insurance it is hard to gauge the impact of the recession on the frequency and severity of losses," says Steve Kelner, head of US casualty at Swiss Re. "So we face uncertainty. Uncertainty leads to risk and that should lead to more conservative behaviour but that doesn't seem to be happening. Competition is simply keeping rates down."
Steve Dresner, senior vice-president of casualty treaty reinsurance at Endurance, says: "The biggest factor facing the market is the economy. Lines of business such as product liability and workers' compensation - those rated on revenue and payroll - have been negatively impacted to a great extent during the past 18 months. Even with business being written at rates comparable to last year, premiums are down as revenues and payroll have fallen."
Some lines of business have had poor loss experience, particularly financial institutions (FI), professional indemnity (PI), directors' and officers' (D&O), surety and trade credit, and political risk, which have all seen double-digit rate increases as a result, according to a report published by Guy Carpenter.
"In Europe, we've seen several major reinsurers withdraw or cut back significantly on financial lines (D&O and PI) liability treaties. The timing of this is surprising in some cases because most of these treaties are on a risks-attaching basis," says David Lewin, managing director at Guy Carpenter. "These reinsurers are left paying the claims of 2007 and 2008 but receiving none of the upside of rate increases and tightening of terms seen this year and probably 2010."
According to figures from broker Jardine Lloyd Thompson (JLT), D&O rates for financial institutions have increased by 25-40%.
The lack of claims outside FI and trade lines has delayed a substantial increase in pricing for carriers in both Europe and the US. Loss ratios for commercial D&O, commercial PI, and general liability (GL) have been below expectations in Europe since 2002. Lewin asks: "Will this trend of relatively benign claims activity in these lines of business continue?"
"Commercial D&O rates are still going down despite losses and record bankruptcies. While bankruptcies are not a guarantee for a loss, it does increase the odds significantly," comments Bender. "There is a lot of 'peanut butter' out there; it is mainly soft, with the exception of FIs," adds Kelner.
According to JLT's figures, competition in the market for D&O for commercial companies has produced reductions of 5-10%.
Market competition remains strong because, although according to Guy Carpenter's figures (re)insurers did lose a considerable amount of capital (18-20%) during the financial crisis, there were few casualties: the stability of the industry was never truly threatened.
"Traditional capacity that has long dominated the umbrella-excess landscape remains intact and true to its long-term underwriting objectives," writes Paul Smith, excess casualty practice leader at Willis North America in a market commentary. According to Smith, these include Chartis, Ace, Zurich, XL, Chubb, Fireman's Fund, Liberty Mutual and Great American.
"The continued evolution of markets such as AWAC, Endurance and Arch has proven extremely valuable to clients looking to diversify their programmes, introducing new capacity to reduce single-insurer counterparty risk and increase competition among the traditional dominant players," Smith says. "While some of these insurers may not be able to offer the same limit as the main lead players, that should not be a discouraging factor."
New entrants to the casualty market include Canopius, Torus, Argo Re, Starr Indemnity Liability and Ironshore.
"They have staffed themselves with industry-veteran leadership and underwriters with long-term plans that will undoubtedly increase their capacities, appetites and participation on many accounts as they mature. These markets have big plans and, like many insurers born in 2001-2002, they too will likely evolve into major participants in this space," says Smith.
"Veteran players such as Swiss Re and Allianz are either reinventing themselves or re-entering the market in an effort to position themselves for the long-awaited market cycle change," he adds.
Swiss Re has opened offices throughout the US, is using a new policy and is chasing the middle market hard, whereas the company's business used to be predicated on top-end clients flying to Europe to deal with them, according to Smith.
"It is about the risk-reward equation; having not necessarily done the best job in the last hard market cycle. We are trying to be there to offer our capacity for when the market hardens," says Kelner.
Meanwhile, Allianz has returned to a market that it exited after 2001's losses and has one underwriter based in Chicago that is writing very specific, targeted accounts, says Smith.
On the primary side, one key reason for the competitive environment is the continued participation of AIG when many carriers were expecting the giant's customers to be looking elsewhere for cover and for prices to increase accordingly.
"The increases, in fact, created opportunities for other carriers to step in and take the business. Overall, AIG's competitors were disappointed because many AIG primary casualty clients, if not most, rode out the storm and stayed put. Similarly, some insurers anticipated that a flight to quality would support higher prices; this too never developed," says Smith.
"Many programmes have gone to market to ensure that the buyers are getting the best deals with the best carriers. However, very few programmes have actually moved in the end," he continues. "Buyers are very keen to look at expanding their placements and gaining more participants, so new carriers are finding the chance to participate. It is the same risk but spread more thinly and diversified from the buyer's perspective."
There is some discontent among AIG's rivals, though. Bender comments: "This unprecedented intervention is giving some companies an unfair market advantage, prolonging market softening."
Another issue for the casualty market arising from the wider economic climate is the danger caused by inflation. As interest rates begin to rise again, the economic environment could become still-more challenging for long-tail (re)insurers to write profitable business in.
"Monetary inflation may not be a concern now but many worry about the medium-term prospects. In the short run, a worldwide recession and depressed growth levels have kept the risk of inflation contained," says Lewin. "Yet quantitative easing and governments pumping money into the financial system could set the stage for a spike in inflation a few years from now."
He continues: "Inflation poses a problem for long-tail insurers and quota-share reinsurers, unless they have a sufficient time horizon before claims must be paid. Investment income from both premium and reserves is used to offset the cost of inflation-affected claims."
Inflation is not just confined to standard measures like retail prices or average wages and salaries, it can be hidden in other economic measures such as legal, social, medical costs and emerging risk inflation.
Against warnings such as these, it is vital that casualty (re)insurers not only ensure that they are receiving the necessary premium rates but also make certain that investment portfolios strike the correct balance between risk and reward.
"Pricing is the key concern because we are not seeing weakening terms and conditions in reinsurance, although we are seeing it in the primary market," remarks Kelner.
As competition remains fierce and capacity more than ample, it would appear that underwriting discipline is unlikely to return to the market before the next major renewals on 1 January.
"I think it is going to be a little bit flat but we will be in a better position to know after PCI," says Dresner.
As market hardening appears a remote possibility before the next renewals, carriers will be looking for a market-changing event to prompt an upturn in the cycle, wondering what that event may be and when it might happen.
"Last year, it looked like we had that with the fall in asset values but they have recovered very well and it has not driven a hard casualty market. It sounds like there is broad agreement that pricing is inadequate at the moment but nobody seems to know what to do about it," comments Kelner.
Smith adds: "I do not think we can separate casualty from other classes of business. I believe the market will change after a series of events that facilitate that need, whether they be property catastrophe events or terrorism or whatever they may be. But there is no sign of a market-changing event in the short to medium term."
"Reinsurers are facing shrinking exposures, increased inflation and rate decreases and this market will be with us for up to two years," says Bender.
In the meantime, (re)insurers will be looking out for opportunities within the sector such as environmental liability, which could see increased demand for coverage following European legislation including the Environmental Damage Liability Directive.
"Environmental liability is seen as an opportunity in the market with new players entering. Most recently, this has been a relatively soft area. As the economy recovers and properties begin to change hands, demand for environmental liability will likely increase. Companies can be expected to seek protection from liabilities that might be assumed in commercial mergers and acquisitions activity, like those related to older buildings and potential environmental exposures," comments Dresner.
Other risks will emerge from science and technological developments. "What are the risks attached to new areas of research and development like nanotechnology?" says Lewin.
He continues: "It is difficult for insurers to keep up with underlying product risk developments but there is a lot of research going on. Technological developments may lead to new injuries and diseases but, on the other hand, they could enhance the ability of victims to avoid injury or to recover from those diseases."
And while President Obama's proposed healthcare reforms are far from complete, they too could produce opportunities. "While it's too early to tell what healthcare changes may be enacted by Congress, one sector that would likely benefit from healthcare reforms is workers' compensation. With more people covered by medical insurance, there may be less incentive to utilise the workers' compensation system for some medical claims," argues Dresner.
With rising numbers of recession-related claims, threats of inflation and emerging risks, the next year could therefore be tumultuous. The message is that, if rates do not rise at the 1 January renewals then casualty reinsurers could face even harder times.
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