From the February 2012 issue of Investment Advisor • Subscribe!

P/C Currency Complications

You already knew rates would be going up, but do you know why?

The year just passed was a challenge all the way around—tough markets, political unrest, economic woes, natural disasters. In fact, it was the most expensive year ever for the insurance industry, beating out 2005 with its triple hurricane threat of Katrina, Rita and Wilma. According to Munich Re and the Insurance Information Institute, property/casualty losses worldwide totaled $380 billion in 2011, way ahead of 2005’s $220 billion. For reinsurers, it was also the highest loss year ever, when measured in dollars, according to reinsurance broker Holborn Corp.

The United States had its share of expensive troubles between the Gulf oil spill and numerous storms, but perhaps not on the scale of the triple disaster in Japan, a devastating earthquake in Chile and Thailand’s recent troubles, where severe and sustained flooding has disrupted supply chains all over the world and final costs are still being reckoned. Still, in the interconnectedness of the global economy, the flight of a butterfly somewhere will cause a cataclysm somewhere else, and your clients should be ready—because it’s going to cost them more.

Paul Kneuer, senior VP and chief reinsurance strategist for Holborn, termed the reinsurance market “brittle” in a recent A.M. Best interview. With reinsurers being hit with their first overall loss for the year since 2005—combined ratios are expected by Holborn Corp. to come in at 105-110 for the end of the year—costs were already slated to go up. (See “Sticker Shock,” Investment Advisor, Nov. 2011)

That was obvious earlier in the year, with the cost of Fukushima, Deepwater Horizon and New Zealand’s earthquake. To those have now been added Australian flooding, New Zealand aftershocks, the Chilean earthquake, Hurricanes Irene and Lee, tornadoes in the United States and flooding in Thailand.

And that could be just the beginning, with a factor other than insured losses weighing on reinsurers and insurers alike: the euro. According to Holborn’s report “The 2012 Reinsurance Market: Changing Tides,” the need to write down sovereign European debt has already had an impact on capital levels at insurers.

Earlier use of flexible capital instruments had allowed insurers to bring in more capital from investors and had cushioned them from much of what has occurred in the eurozone. However, said Holborn, with some European regulators suggesting that all government bonds be carried at less than par value, “[t]his would sharply reduce the capital levels and share prices of insurers and banks in the peripheral countries, and to a lesser extent in the stronger economies of France, Switzerland and Germany. The likely restructuring of the EU and the eurozone may cause large swings in capital levels for certain reinsurers during 2012 and is a further source of uncertainty.”

Holborn isn’t the only company concerned about the effects of the eurozone crisis on the insurance industry. London reinsurance broker Willis Re also said in its 2012 report “1st View: Change is in the Wind” that the loss of capital surplus, which had contributed to strong competition in the industry, would see that competition and its attendant low prices come to an end as premiums rise.

With reinsurance at a premium as companies impose quotas on regions or types of business, insurers will be more dependent on stricter underwriting and other instruments, such as catastrophe bonds. However, cat bonds themselves are seeing losses, according to Holborn; hedge funds are moving away from insurance bonds in favor of potentially higher returns on European bonds with higher interest spreads, and new cat bond commitments in 2011, says the company, were lower than in 2007. The two concerns for your clients in 2012 are both cost and availability of coverage—both property/casualty and business interruption.     

 

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