Insurers and reinsurers are challenged by low interest rates and decreasing returns on their asset portfolios are forcing them to generate higher return on equity from underwriting. But as long as the economy is not growing it is doubtful whether any insurance rate increases will positively affect the bottom line, according to Bart Hedges, CEO of Greenlight Re.
Speaking at the Cayman Captive Forum, Hedges explained insurance and reinsurance companies either make their money from underwriting or investing. On the investment side, prevailing low interest rates cause the predominantly fixed income portfolios to yield ever lower returns. This in turn means that the ability of insurers and reinsurers to generate return on equity is diminishing.
“It is a point in the market where people will stretch, trying to do things on the underwriting side to generate more return on equity and it is a very dangerous time in the cycle,” Hedges said.
Although the problem is being recognised, doing more on the underwriting side is likely to result in higher insurance rates to increase profitability.
The problem, said Hedges, is that the economy is not growing. “The pie is not getting any bigger and not only is the pie not getting bigger, the capital base of the respective companies is getting larger.” As a result, the market place stays challenging because balance sheets in the industry are in good condition and competition is heavy across all lines of insurance business.
The other issue, he raised, is whether rate increases of 5, 6 or 7 per cent claimed by some commercial insurers are going to affect the bottom line and improve combined ratios, an industry measure of profitability that divides incurred losses and expenses by insurance premiums.
“Because people are finding ways to buy less insurance and they do it either through higher deductibles or they do it through buying less coverage. They even decide not to purchase insurance and the reason is people are not having any more money to spend right now. That is the big headwind.”
In his opinion the industry is doing exactly what it is supposed to do: Return on equity is falling, capital managers are looking for higher returns and rates are starting to go up. “But unless the economy gets better, it is difficult to see how the rate action will really result in better combined ratios for companies and I think that is the big issue.”
Super storm Sandy that hit the East cost of the US in late October caused more than $20 billion worth of damage, even though it has wind speeds of only 80mph or less when the storm hit the coastline. Flood losses will not be covered by private insurance but the taxpayer funded National Flood Insurance plan. Despite the remaining costs, which could still rise, the industry has sufficient reserves and the risks are spread widely enough. While the industry is in a good position overall to absorb the losses, with Sandy the only major catastrophic event in 2012, segments of the market can be affected significantly.
“There are expected to be $650 million in personal watercraft losses,” said Hedges, referring to it as an example for one of the normally lucrative niche markets that insurers and reinsurers love to find.
In addition events that cannot or are not being modelled, yet result in substantial losses, represent another challenge for reinsurers. “We saw it in Katrina, the levies were supposed to hold to CAT2 or 3 and they did not. Japan never even modelled a 9.0 earthquake followed by a tsunami,” said Hedges.
In Christchurch liquefaction, where loosely packed, water-logged sediments came loose from the intense shaking of the earthquake, means that part of the city cannot be rebuilt, he added.
“What is the cost of that? It is again an unknown unknown. Then the Thai floods; we are still figuring out what the exposure is, because it was in a territory that was unmodelled and right now it is the third biggest loss for Lloyds.”