Best's Review

AM BEST'S MONTHLY INSURANCE MAGAZINE


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At Large
Heading for Trouble

Three trends suggest the market is in for a rough ride.
  • Stephen Catlin
  • November 2019
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In the August issue of Best's Review, I looked ahead to this year's Rendez-Vous de Septembre, the annual gathering of the reinsurance market in Monte Carlo. Now that the Rendez-Vous has concluded, I would like to reflect on my discussions there to highlight some important issues.

First, there is a growing consensus that companies will be strengthening—rather than releasing—loss reserves for casualty business over the next five years.

Some of the bigger reinsurance carriers are privately admitting that they have reserve shortfalls. If reinsurers need to strengthen their casualty reserves, it's only common sense to believe that primary insurers will be required to do the same.

Some of this reserve deterioration is from business underwritten 10 years ago or even longer. That said, casualty business is now priced at about 50% of what it was priced a decade ago. So, if a company has casualty reserve deficiencies from 10 years ago, it also likely has problems arising from business written much more recently.

In my opinion, this issue could play out in one of two ways: Either companies will begin strengthening reserves gradually over time, or at least one company's external auditor or actuarial adviser will demand that immediate action be taken.

Once one major company announces that it must strengthen reserves meaningfully, others will most likely follow suit. This is what happened in 2002-2003, the last time that the industry strengthened casualty reserves on a widespread basis.

People who I respect were willing to discuss this problem fairly openly. Others would not; either they simply did not want to recognize it or they simply have their heads in the sand.

Alternative capital was another important topic. While some experts believe that the amount of alternative capital that has disappeared recently due to “loss creep” and other factors would be replenished quickly, others are not too sure.

What is clear from my discussions is that the amount of alternative capital that is now “trapped”—and therefore cannot be redeployed— is increasing. I think the jury is still out on whether additional alternative capital is ready to flow into the market given that the capital already invested did not produce the expected returns.

If the amount of alternative capital decreases, demand for traditional reinsurance protection will increase. However, some traditional reinsurers also are cutting back on capacity. The market for retrocessional coverage, for example, is in disarray, which reduces some reinsurers' appetite for catastrophe coverage since they cannot easily lay off their cat risk.

These trends—inadequate casualty reserves, a perceived decrease in alternative capital and reduced risk appetite by traditional reinsurers—could mean that the market will face a rough ride over the next five years.

Yes, there is a sense that rates are on the upswing. However, if rates are cut in half over a period of time, a 40% rate increase still does not mean rates are adequate. If a company charged $100 for a risk 10 years ago and now charges $50, a 40% increase only results in $70 in premiums.

 

Note: This column ran in the print issue of the magazine with the headline Monte Carlo Conversations

Best’s Review contributor Stephen Catlin is the founder of Convex Group and Catlin Group and former executive deputy chairman of XL Catlin. He is a member of the International Insurance Society’s Insurance Hall of Fame. He can be reached at bestreviewcomment@ambest.com.


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