S&P’s 32nd Annual Insurance Conference took place in New York June 14-15 at the NY Marriott Marquis with the title: Managing an Uncertain Reality. Following the meeting, which was attended by a good many industry leaders, the key topics of interest were assembled by S&P Global Ratings and published in three separate articles, as follows:
Global Reinsurers Facing Prolonged Weak Market
New York, NY — The global reinsurance market remains mired in a prolonged soft patch, but there have been signs that pricing may have reached a bottom, said panelists who spoke at the S&P Global Ratings 2016 Insurance Conference in New York on June 16.
“It’s a tough market,” said Constantine Iordanou, chairman and CEO of Arch Capital Group. “On a scale of 1-10, with 10 being a great market and one being a terrible market, we’re at a two or three. But I see some signs of bottoming in some of the sectors.”
With more than half of business written by global reinsurers coming into effect at the beginning of each year, the January renewal season generally sets the tone for the whole year. In a survey S&P Global Ratings carried out in the first quarter, the largest global reinsurers indicated that pricing across lines and regions had continued its downward trend, although the decline was less than many expected.
Brian Young, president and CEO of Odyssey Re Holdings, said he expects pricing for midyear renewals to be down in the neighborhood of 5%, but that “there are signs that the pressure is moderating.”
Contributing to the soft market are a number of factors, not the least of which is consolidation among primary insurers, which, although trimming the number of customers for reinsurers, has also created ever-larger companies that are more willing to retain risk.
“The number of insurance companies is declining,” said Chris O’Kane, CEO of Aspen Insurance Holdings. At the same time, insurers’ increased reliance on modeling has made them more comfortable holding onto risk. “We’ve seen more use of models – especially in Europe – and models give a sense of security. Some people might say models give a false sense of security.”
At any rate, there’s a “supply-demand imbalance that I think is going to be with us for a little while to come,” O’Kane said.
Iordanou agreed, saying that unlike many cycles in the past, “we’ve seen more willingness by clients to retain risk because their balance sheets are healthy.”
“It’s not a question of how much capacity is available, but a question of whether that capacity is willing to take the risk,” he added.
At the same time, enhanced quantitative methods across the sector have put competitors on a more even playing field in many respects, panelists said, which is contributing to softer pricing.
“If you look at past bad markets, there was a lot of very ill-informed competition,” Aspen’s O’Kane said “There were a lot of things ready to go wrong, and when they went wrong, they did so big time.” Now, he said, participants are “better-informed and more disciplined,” though perhaps the effects have already been priced into the market.
“I’m not saying there won’t be some more declines, but I would say we’re reaching the bottom in pricing,” O’Kane said. “The question is, ‘What will get us back off the bottom?’, and I don’t have an answer for that one.”
Odyssey’s Young suggested that a catastrophic event or “another financial crisis, as we saw in 2008-2009 that impairs balance sheets” could be a catalyst for a change.
“You’d need some big losses to emerge,” he said. “Even in today’s soft market, where you see losses, you see a correction” in pricing, as occurred in Alberta, Canada after wildfires swept through and largely destroyed the city of Fort McMurray. Still, “it’s not having a global impact. For us to see corrective action globally, I think you’d need to see (losses of) $50bn – or maybe north of that.”
Either way, the global reinsurance industry has enjoyed relatively good profitability because of the low level of catastrophe losses and high level of reserve releases, which has freed up money set aside to settle possible claims that didn’t materialize.
As Arch’s Iordanou put it: “With no (catastrophes), you can have lousy pricing and still come out ahead.”
Nonetheless, pricing dynamics in the markets have changed, panelists said.
“Historically, the reinsurance market was very volatile: It put prices up significantly after an event, it rode that pricing for a period, and then it lowered pricing very quickly,” said O’Kane of Aspen. Now, “the upturn tends to be a bit milder and a bit shorter” because of improved quantitative disciplines.
He went on to warn about the “drying up of reserve releases, which I think is coming,” and said that, on the underwriting side, “there isn’t really, in this global market, any unnoticed pocket of excellent returns.” Rather than try to explore areas of new business, O’Kane said, “the questions we need to answer now are, ‘How are we going to retain some margin? How are we going to prevent the erosion of margin?'”
Iordanou agreed that finding a large and hugely profitable untapped opportunity was extremely unlikely, and that “you have to go to small or niche transactions to find something where there’s no efficiency in the market.”
“Given the current marketplace in reinsurance, you have to be patient and disciplined because you’re walking through a minefield right now,” he said.
That has fed into (often declining) compensation for underwriters, and has made retention of talent at reinsurers a sometimes difficult prospect. The panelists agreed that remaining disciplined and allowing underwriters to survive a fairly fallow period, was essential.
Iordanou said his firm compensates underwriters based on bottom-line profitability, not top-line revenue. “As (Warren) Buffett says, ‘Premium doesn’t know anything about losses, and vice-versa,'” he said.
As Odyssey’s Young put it: “In this environment, where would you rather work – at a firm that says, ‘You need to write business right now’ or one that says, ‘It’s okay to put the pen down. If the deal doesn’t make sense, don’t do it’?”
The panelists collectively projected that return on equity for the year would be somewhere in the 7%-8% range, but some added that the goal of 15% returns over the longer-term remained.
“We’ll just hunker down,” said O’Kane. “We’ll survive this.”
US P/C Industry Reserve Adequacy, Reflecting Greater Discipline, Still Sound
New York, NY — Reserves for the U.S. property/casualty (P/C) industry continue to surpass industry leaders’ expectations despite an air of skepticism, said panelists at the S&P Global Ratings Insurance Conference on June 15 in New York.
Like other industry observers, S&P Global Ratings had expected P/C reserve releases to decline in 2015 because of softer commercial-lines pricing and less margin in the reserves of older accident years that have supported positive development for the past 10 years.
“Reserve adequacy is always a concern, especially in lines where claims take time to emerge (i.e., long-tail lines),” said John Iten, director at S&P Global Ratings and moderator at the conference. The concerns stem from P/C’s cyclical nature in which soft markets yield more releases because of price competition and hard markets see more reserve strengthening.
Even with this cyclicality, reserves have held up unusually well in recent years. S&P Global Ratings estimates that net reserve releases (excluding mortgage and financial guaranty insurance) totaled $6.7bn in 2015, down from the $9.6bn released in 2014.
Conning Inc. agreed with these findings in its recent publication of 2015 reserve adequacy.
“We think industry reserves are 2% redundant right now, down from 4% last year,” said Robert Farnam, vice president of insurance research at Conning.. “Overall claims trends are benign; frequency trends had been going down, although they may have bottomed, and severity trends have been moderate for the most part.”
Susan Cross, EVP and group chief actuary at XL Group plc, also believes that, based on her analysis of the global loss triangles published by Bermuda insurers and reinsurers, reserves are still redundant overall, but there is a slight shift between the insurance and reinsurance segments.
“The insurance portion of the reserves is much closer to that level of adequacy or are just adequate,” she said. “Reinsurance reserves remain very strong across the market. Some deterioration in the level of reserves has occurred,” she continued, “but they remain strong.”
The panelists remember how reserve adequacy works in cycles though, and they had one takeaway: Even with the trend of favorable development continuing into 2016, it will likely start to wane.
Furthermore, these positive trends haven’t applied evenly to various sectors and among individual companies. Specifically, auto lines results diverged from those of workers’ compensation and medical malpractice.
“For personal auto liability, 2001 was the last time we thought that reserves were deficient,” Farnam said. “We don’t think they’re deficient now, but we think the redundancy has been wiped away.”
Commercial auto has been much maligned in recent years because of adverse reserve development. Despite an increase in vehicle miles driven, claims frequency for auto as a whole has seen only a small increase recently, aided by the impact of technology on automobiles (i.e., automatic break functions, enhanced video monitoring, etc.). Severity has jumped higher, though.
Technology has helped prevent smaller accidents, so the proportion of more significant accidents is higher. The cost of auto repair has increased as well.
Technology has benefited other groups as well. “Aviation is a good example where we’ve had a lot of improvements that have resulted in reduction of events,” Cross said. However, aviation has also experience pricing pressure, which is common when a line shows loss improvement. Aviation’s favorable reserve development has fortunately balanced out this pressure.
In terms of strong reserves, workers’ compensation and medical malpractice (which has more than a 20% redundancy per Conning) lead the charge. Because the former carries a quarter of the industry’s total reserves, its adequacy is important. In 2015, favorable reserve development knocked down the workers’ compensation loss ratio by about four percentage points. Pricing has improved, claim frequency has declined, and severity hasn’t been too substantial due to more modest medical inflation trends relative to earlier periods. But some of these strengths have resulted from the economic recession and its prolonged recovery.
Claims dropped dramatically in 2008 and 2009 in the midst of the recession simply because workers were leaving the workplace. Specific industries with a higher incidence of claims, such as construction, manufacturing, and transportation, lost more workers than others, which helped lower workers compensation claims frequency.
“These industries haven’t really rebounded much,” said Conning’s Farnam, “which is one of the reasons why workers’ comp has done well.” But eventually these sectors could improve, driving up claim frequency.
One factor has arisen as the largest disruptor on future reserves time and time again, the panelists said: inflation. It’s made predicting future reserves difficult, but insurance companies are taking different initiatives to ease the pain.
“Many companies are investing in methodologies to come up with reserve ranges,” said Sridhar Manyem, director at S&P Global Ratings. “Their stress testing is looking at the impact of inflation on reserves.” These companies are also taking greater steps than in prior years to better predict frequency and severity increases and insolvency.
Besides inflation, insurance companies are investigating other emerging risks and their impact on reserve adequacy. For example, Cross stated that XL Group has kept an eye on nanotechnology, fracking, cyber threats, concussions, e-cigarets, and Brexit, and has questioned how these risks could affect underwriting if they occur. On the global front, the U.S. judicial climate could affect other regions and countries. Certain types of claims in the U.S. have not yet migrated.
All of these trends, disruptors, and individual findings point to the larger question of whether reserve adequacy has reached its inflection point. If not, when will that occur? Fortunately, according to Farnam and Manyem, the insurance industry now has a greater level of discipline to handle a market switch than it did in 2001, for example, when asbestos and environmental claims shocked the system.
“In insurance, you can go a long time without losses, and then you see a trendm that can create a lot of noise,” Manyem said.
If 2016 is the year to rock reserves, at least insurance companies will be better prepared to tackle it.
Insurance Regulation Clarity Still Out Of Reach: S&P Global Ratings
New York, NY — Looks alone won’t tell you everything you need to know about an insurance company. To figure that out, you have to look under the hood, especially when determining an insurance company’s risk. This was the mantra at the regulation panel of the S&P Global Ratings Insurance Conference on June 15, 2016.
In 2013, the Financial Stability Oversight Council (FSOC), which is part of the Federal Reserve, began designating companies as non-bank systemically important financial institutions (SIFIs) if the council thought one of these institutions’ failure could threaten the stability of the wider markets. Three non-bank institutions currently are designated as SIFIs in the U.S. Additionally, on the international front, nine large global insurers are labeled with the global version of SIFI, global systemically important insurers (G-SII), which means they must follow the regulations that fall under the Financial Stability Board’s (FSB’s) purview. The International Association of Insurance Supervisors (IAIS) makes proposals to the FSB.
Because the international community’s capital regulations won’t be implemented until 2019, the debate continues as to which insurance companies fall into these “systemically important” categories. And Roy Woodall, an independent member of the FSOC and one of the conference panelists, was adamant about “looking under the hood” to make these determinations because every company varies.
The debate doesn’t just consider one country’s stability. It’s both broader-based and more specific. “Some of the range of the debate about being systemic is the impact an institution could have on the rest of the financial sector,” said Craig Thorburn, lead insurance specialist with The World Bank.
Closer inspection of an insurance company’s risks requires the analysis of its products and portfolios. The executive vice president of global risk management at MetLife, Graham Cox was more critical of the SIFI and G-SII designations and of the IAIS proposals. “We haven’t had a real fundamental analysis of whether the insurance industry is systemically risky,” he said. “IAIS was asked which ones are risky rather than asking if insurance companies or certain activities are systemically important or risky. There’s a difference.”
According to Cox, part of the IAIS’s plan that needs improving is the identification of non-traditional, non-insurance (NTNI) products, those that diverge from traditional insurance. For example, derivatives and variable annuities are considered NTNI products despite their frequency in the market and the use of derivatives often to hedge the product risk. Having these on balance sheets will count toward NTNI, as per the IAIS current basic capital regulation.
“We now think of things in two categories, and it’s confusing.” Cox said. Some products that are thought of as non-traditional are debatable as to whether they contain significant risk–funding agreements are an example. “We’re not doing anyone a service by focusing on non-traditional instead of focusing around which activities might engender systemic risk and why,” he continued.
On the domestic front, insurance regulators face a diverse landscape that deeply affects the types of proposals they make and the effectiveness and risk of these proposals. Also, insurance is fundamentally regulated via a state-based, and not a federal, framework. “Faced with that kind of diversity, it does complicate things,” Thorburn said.
Lastly, panelists seemed to disagree on the value regulation has added to insurance companies. Thorburn recalled the number of risks decreasing after the Securities and Exchange Commission (SEC) started measuring it for individual companies. “If you start measuring things, people start asking if it’s something they want to keep doing and if it’s worthwhile.”
But Cox sees things differently. He believes the insurance industry was catalyzed by its own lessons after the financial crisis. “We’ve reduced risk accordingly,” he said. To Cox, there’s no proof that various measurements have affected the amount of risk-taking. It was the industry itself that managed those risks.
But as Thorburn pointed out, many of these proposals are just that: proposals. And they are very much still works in progress. One of the greatest tasks that the international bodies have faced over the years and especially now is implementation. “It’s not a translation into local law,” he said.
A lot of heavy lifting still needs to be done before these rules are finalized. The panelists agreed that, for the time being, the insurance regulation scene remains murky without an indication of when clarity will set in.
Link to Conference Agenda