Troubled waters ahead?

Let nature take its course and the aftermath can be devastating. A few hurricanes, earthquakes and some flooding and reinsurance rates start to rise, companies go bust and the whole market is shaken up.

We should not be surprised though. A glance through history shows that disasters - both natural and man-made - lead to massive claims, which in turn shake up the reinsurance sector.

Take the eighties and nineties, for example. There were gales and storms in the UK, the Exxon Valdez oil spill and the Phillips Petroleum leakage, which cost the industry billions. Disasters inevitably happen and the claims roll in. It may seem like a natural cycle that will continue throughout the future, but the insurance impact will eventually fall at the reinsurers' door.

For their part, the reinsurers who agreed to foot the bill after claims reached a certain level or pay a percentage of a claim made a costly decision.

A look at costs over the last half century shows that storms can result in $7b (£4.8b) worth of damage in Europe every ten years. But a series of major incidents and natural disasters in 1999 such as flooding in Venezuela, a typhoon in Japan, tornadoes in America and satellite losses led to massive losses. On top of that, in December, two unexpected major storms shook up the whole market. Hurricane Lothar went through France, Germany and Switzerland and Hurricane Martin also brought destruction and chaos. The tab totalled a hefty $18b (£12.5b) of economic losses.

In addition, the same year saw the Sydney hail storm, a storm in Denmark plus earthquakes in both Turkey and Taiwan. The reinsurance market, which traditionally renews its policies on January 1st, was unprepared for the disaster. It had already spent the last quarter of the year drawing up new exhaustive contracts, which were already in place. By the time the gales had struck, it was too late to estimate the impact of those claims into the following year's account.

For some, the consequences were devastating. Serious losses struck the French market and this followed through to the UK.

The vast reinsurance claims contributed to the withdrawal of many players, the majority of which were Australian companies. Notable exits over the past few years include New Cap Re and ReAC - key figures that lost hundreds of millions of Australian dollars.

Others have merged to keep their head above water. GIO Re was one of the larger names, being acquired by AMP and having a cash injection of $1.2bn Australian dollars.

But because of the massive claims, all the survivors had a price to pay.

The loss ratio has been high, exceeding over 100% in some cases as companies pay more out than they are getting in. A report of the top global reinsurers published in September last year revealed Folksamerica Reinsurance Company had a non-life combined ratio of 120.3%, while Fairfax Holdings and Odyssey Re Group had 119.4%. In 1999, the average combined ratio of the European reinsurance industry was a staggering 131%.

Consequently, reinsurers have been forced to up their reserves for natural catastrophes to pay for the costs of 1999 - even though there were no major disasters last year. Swiss Re has increased its reserve by 20% while Zurich Financial Services has raised it by over £200m.

New definitions
Large claims have also resulted in rates being pushed up across the board, as those who have lost money have finally been able to force through increased prices.

Damien Smith, Hiscox' deputy underwriter for treaty reinsurance, says: "Rates will go up, there is no doubt about it. Some will go up by 25% or more, although it depends on the area. This has gone through everyone's reinsurance programme."

But it is not just natural catastrophes that have shaken the reinsurance sector. In 1999 claims for the Swiss Air crash were estimated to be equivalent to nearly the whole year's premium income for the entire global aviation insurance industry.

Previously, aviation rates did not even pay for routine damage, like being hit by birds, but now some have been raised six-fold.

A spokesman for the International Underwriting Association, where two-thirds of non-marine treaty reinsurance takes place, remains unsurprised by the new figures.

"Rates had become unsustainable," he says. "It was inevitable that they would start to rise again."

Policy terms have also been affected. Swiss Re is currently deliberating altering its hours clause to ensure a common understanding of the term `event' and provide sufficient flexibility for solutions tailored to the specific needs of a given company or portfolio.

New definitions may lead to adjustments on catastrophe covers and in theory could help cut down on expensive claims. If a reinsurer agrees to pay out for a claim, only once it has reached a certain level, by limiting the number of hours in which a single event can happen, insurers will pick up the brunt of the damage and the reinsurer will have less to pay out.

In this era of already rising rates, struggling companies and changing policies, what will the future hold as more claims roll in? At present, industry experts are predicting a period of increased rates since some renewals based on three-year policies have yet to be drafted.

Yet many regard these developments as little cause for concern.

Smith says: "Rates really need to go up - they've been low for a long time."

Peter Taylor, chairman of Insurance Solutions, adds: "Because catastrophe losses are usually borne by reinsurers and the deductibles are still relatively low, there is a little real incentive for direct writers to increase their rates."

Some consider this merely a cycle. In 1993-4 the market saw a peak, with UK rates three times as high as in 1989, following claims submitted after Florida's Hurricane Andrew in 1992 and UK storms in 1987 and 1990. It may just be a case of history simply repeating itself.

Charles Catt, who was a lead company market underwriter on nearly all the major catastrophe programmes when at the NW Re and NAC Re, agrees. He is also a founder chairman of the Technical Underwriting Executive Committee of the International Underwriting Association of London and says: "Current catastrophe losses will continue to influence the market. But the market never stands still, it is always changing.

"At the moment it is going through a continuation stage, where reinsurance rates are moving after many years of stagnation. This suggests reinsurance is going through a better period."

Others regard the changes to policies as a much needed redrafting of current clauses.

Clemens Von Bechtolsheim, managing director of Munich Re, comments: "During 2000, we have not been hit by extraordinarily large claims which would have required changes to policy wordings, changes in clauses, or rate increases due to large claims.

"On the other hand, increased attritional losses in a number of areas and generally insufficient reinsurance terms in recent years made improvements in market conditions necessary. We are pleased to have achieved some improvement in terms during the renewal season for 2001."

Rates will continue to climb
Catt considers alterations to be part of an evolution of classification . But he admits there is a downside to the changing reinsurance world. "It has led to a lot of consolidation in the market, and there is more of it to be seen as the market evolves. It can be worrying that the client's choice diminishes."

How long will the rates continue to climb as a result of incoming claims?

The market consensus is that they will go on rising, but few people are predicting a return to the boom levels of the mid-90s. Some believe they may eventually reach a plateau.

Overcapacity will push up rates, and people are now looking for different ways to insure and reinsure, such as through Alternative Risk Transfer. Retrocession is another reason why rates should rise. Rates to reinsure reinsurance were an estimated 25% higher at the last renewal season than in the previous year. This will have an impact on the price of reinsurance.

The claims seem neverending. Munich Re's initial analysis of the events caused by natural hazards in 2000 revealed losses of around $30b (£20.8b), compared to $100b (£69.5b) the previous year. But their report stated: "The number of natural catastrophes reached a new absolute high, with more than 850 recorded worldwide. In spite of the overall loss balance being favourable in 2000, there is no justification for speaking of a change in the trend as far as loss and damage is concerned."

Royal & Sunalliance Insurance Group has estimated that Canadian, UK and European storms and floods have brought about losses of between £180-200m. Bob Mendelsohn, group chief executive, comments: "The trend towards higher commercial rates has continued. Our approach to rating is based on long term trends, and although rates will rise, we do not expect a dramatic change in rate levels in the areas affected by storms and flooding."