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Monday 23 July 2018


Standing firm

Written by Helen Yates
February 2011

With increasingly tough operating conditions throughout the insurance industry, paying lip service to underwriting discipline is no longer an option. Helen Yates reports on the year ahead in underwriting

As the London insurance market enters a new year, it is crystal clear what will dominate the insurance agenda over the next 12 months: underwriting discipline. Yes, senior management have plenty of other priorities in the year that lies ahead – including preparations for Solvency II and portfolio optimisation – but in the absence of a market-changing loss, the main concern will continue to be underwriting for profit.

“The tough market and economic situation will remain on the agenda for 2011,” says Donal Kelly, regional operating officer, UK & Ireland for XL Insurance. “With lacklustre investment returns, maintaining underwriting discipline will continue to be key. Solvency II will also move up a step, as insurers start to validate their internal models.”

Growth in the current environment will also prove difficult but those insurers with efficient operating models will be able to seek out opportunities in new markets or with new products.

Absent a significant cat event, Kelly thinks sustained unprofit-ability by insurers will eventually lead the market to turn. But at present, London market insurers continue to grapple with dwindling returns on both sides of the balance sheet as they enter a new year. While most balance sheets have recovered from the financial crisis, the stagnant economies of the West and low interest rate environment continue to dampen investment returns. At the same time, softening premium rates on most lines of business is making it increasingly tough to make an underwriting profit.

Despite only moderate losses from catastrophes, claims inflation is proving a growing burden on longer-tail lines of business. “The results of 2011 for the London market will be highly dependent on the level of catastrophe losses,” says Catherine Thomas, managing senior financial analyst at AM Best. “But on the casualty side particularly, a sizable inflation spike could increase claims severity and trigger adverse reserve development, particularly for those casualty insurers with above average reserve leverage.”

Reserve releases can no longer be relied on to compensate for poor returns. “There is the expectation that prior year reserve releases, which have made a significant contribution to results in recent years, are likely to diminish,” she continues. “Together with the prospect of lower interest rates, this doesn’t seem to be having any discernable effect on pricing as yet.”


The soft market continues to soften. That was the consensus from the London market’s main reinsurance renewals on 1 January. Prices were down by an average of 7.5 per cent across the various classes according to Guy Carpenters Global Property Catastrophe Rate on Line Index. It identified moderate loss activity and high levels of industry surp-lus as two key factors putting downward pressure on rates.

While it may seem contradictory, given depressed investment returns and a soft insurance market, the industry is awash with excess capital. Insurers never took a big hit from the financial crisis, emerging in good health compared to the banking sector by virtue of their conservative investment strategies. At the same time, losses from US catastrophes have remained relatively low over the past five years – with no US landfalling storms in 2010. “You have seen a second year of fairly limited US cat losses which leads to further pressure to reduce pricing,” states Thomas.

That’s not to say there haven’t been catastrophes; there were plenty in 2010 but most were outside of the industry’s peak zones. While many were human catastrophes, including the Haiti Earthquake and Pakistan flooding, they occurred in regions with low insurance penetration.

Nevertheless, the Chile Earth-quake a year ago, New Zealand earthquake in September, Deep-water Horizon disaster and ongoing Queensland floods are just some of the events that did put a dent in insurers’ earnings.

According to Munich Re, the total insurance bill from natural catastrophes in 2010 was US$37bn, making it among the six most loss intensive years for the industry since 1980. But such losses have failed to have any discernable impact on pricing.

This is a sign of just how competitive the market currently is with plenty of excess capacity available, thinks Richard Pryce, president of ACE UK. “The industry had significant catastrophe losses during 2010 – particularly in Chile and New Zealand – plus some smaller activity but it hasn’t impacted heavily on the market,” he says.

“Estimates cite the total global cost to the industry at somewhere between US$35bn and US$40bn for 2010 – but except for some localised effect, the market has not experienced any significant change,” he continues. “This shows that US$40bn doesn’t do it – it would take something in the region of US$50bn to US$100bn to change things, with the way the market is positioned at the moment.”


According to Pryce, the only option in the current environment is to be prepared to walk away from underpriced business. “You don’t like doing it but there’s no pressure on anyone in this organisation to write business for top line,” he says. “If it’s not the right risk, if it’s underpriced, we won’t write it and we won’t accept it.”

However, he is doubtful whether all players in the market will adopt such a disciplined approach. “Everybody talks a good game but life is not necessarily like that and there are multiple and regular instances where companies will have a different view on price than us,” he explains. “This means we’ll walk away from business and they will underwrite it – maybe they have a tolerance to run over 100 per cent combined ratio in their organisation; but we don’t.”

There are some signs that the market is cutting back on capacity for classes now deemed unprofitable. At Lloyd’s, stamp capacity for 2011 is flat at £23.3bn with a number of syndicates opting to pre-empt in anticipation of continued softening. This includes Ascot, Kiln, Hiscox and QBE. Meanwhile, others gained approval to pre-empt while a couple of new entrants, including Skuld and Scor, are bravely adding their capacity to the mix.
Thomas thinks a certain amount of discipline is being maintained in the market. “Insurers are looking at their portfolios, looking at their lines of business and looking to increase on lines of business that are still robustly priced and maybe cut back on other lines of business,” she explains. “Rate-wise there are some pockets of improvement... so post-Deepwater Horizon offshore energy prices there have been some large rate increases, although maybe not as high as some players had initially hoped.”

Capital management will continue to be important. While some insurers are increasing dividends and share buybacks – such as Hardy and Beazley – in an effort to pass some of the excess back to shareholders, this could make it difficult for them to seize any hard market opportunities should prices turn. While capital raising is easier than it was during the height of the credit crunch, there are still no certainties, says Thomas.


One silver lining in the softening market could be Solvency II. How the new European regulatory framework is likely to impact insurers when it comes into force at the start of 2013 is likely to become much clearer in 2011. “The deadline is the beginning of 2013 and it’s fast approaching so without a doubt there will be a lot of focus and a lot of resource – both time and money – going towards Solvency II at the moment,” says Thomas.

A major change in UK financial services regulation could prove an additional burden as companies look to gain momentum on Solvency II over the course of 2011. The disbandment of the Financial Services Authority and introduction of new regulatory bodies – the Prudential Regulation Authority and Consumer Protection and Markets Authority – comes at a critical time.

Results from the fifth impact study are due out in the spring and market participants are waiting to see whether diversification by geography and lines of business will be as important as many anticipate. If it is, Solvency II could help to boost demand for reinsurance cover as less diversified or monoline players seek contingent capital amidst higher capital requirements.

A higher capital charge for catastrophe business under the regime’s standard formula could also prompt various tactics in the market. Insurers could seek additional cover and/or a re-evaluate their book of business. Mergers and acquisitions are also one way of gaining a more diversified portfolio given the right fit. Although with most insurers trading below book value at present, a major uptick in M&A activity looks unlikely.
Serious cat writers are likely to continue to work with the regulator to gain internal model approval. “In the London market and particularly for Lloyd’s, internal capital model approval is very important,” says Thomas.

In anticipation of higher demand for reinsurance cover, a number of London market players and some Bermuda entities have set up shop in tax-friendly Switzerland over the course of 2010. Switzerland is hotly anticipated to be the first jurisdiction to gain equivalency with Solvency II. Amlin, Allied World, Catlin and Novae are among those that have made the move to growing reinsurance hub Zurich. Others could follow suit in 2011 as they look to establish a presence to serve the Continental European market ahead of the new regime.


In a fiercely competitive market any opportunities for growth and expansion are quickly diminishing, but this doesn’t mean they are absent altogether. Shrewd, well-capitalised London market insurers will continue to make strategic decisions over the next 12 months to expand into new territories and emerging markets, develop innovative products and tap into unchartered distribution channels.

“New products or services can be a real differentiator, especially in the current market environment,” says XL’s Kelly. “We encourage underwriters to spot demands or emerging trends and have procedures in place to facilitate an efficient product development process.”

This activity could well be much slower than in a hard market, but interest in the BRIC economies, emerging technologies such as renewable energy and innovative insurance solutions such as microinsurance could continue to gain momentum. Others may look to try their hand at classes plagued by high loss activity in the hope of reaping firmer rates while avoiding the poorer performing accounts.

“There is still an opportunity to create some growth in the right sectors even though it’s a very competitive market,” says Pryce. “It’s in those areas that provide a better margin or those areas where there’s not as much competition. If you’ve got the capability in the organisation that’s what you should be focusing, on rather than swimming in the market with everyone else and going for easier, low barrier to entry markets – which will inevitably attract the excessive competition.”

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