Is There a Reinsurance Paradigm?
September 2006
Paradigm, a classic example, a rule, a mirror
of, a type, prototype—in short, a change that occurs over a period of time,
but does not necessarily present itself.
by Peter
M. Polstein
Let's look at a potential paradigm that appears to be presenting itself in
this reinsurance marketplace. I have discussed some of this both recently and
in the past, and while I don't want to come off as a "one-trick pony," there
have been a number of both interesting and significant changes which have occurred
over the past months. What I find fascinating is that they occur, they are reported
in one fashion or another, and virtually no one says anything, this despite
the fact that they may well have a profound effect on the marketplace.
Let's Build the Case for What Appears To Be a Paradigm
First, 23 reinsurance companies reported their 6-month loss ratios, proud
of the fact that they decreased from 105.8 to 96.5, their net written premium
(NWP) was some $13 billion versus $ 13.21 billion (reported by 26 reinsurers
for a like period in 2005). It would appear that their NWP was fairly flat,
and while ratios that decrease are laudable, they hardly define the truth which
appears many months or years out. You will note that gross written premium (GWP)
was not discussed.
Ah, but now we find that Alien Reinsurance GWP increased during 2005 over
the prior year to $62.1 billion or almost a 17 percent differential. Additionally,
the Alien share of the U.S. unaffiliated market rose some 85.4 percent.
Perhaps the statistics are nothing more than a boring assembly of unimportant
numbers, until you consider that this marketplace is currently being discussed
by a wide variety of regulatory and governmental agencies with an eye toward
a significant reduction of collateral requirements. Perhaps, it is unnecessary
to remind the readers that these insurers are for the most part, unlicensed
(in the sense of state regulatory issues and guarantees to policyholders), unauthorized,
and simply acting in the capacity of major reinsurers of this industry on the
basis of adequacy predicated on a substantial variety of financial rating organizations.
Without questioning the veracity of the rating organizations, which at times
have proven to be inadequate, it begs the question, why would we take a position
which under a worst-case scenario, can critically wound, if not kill, an insurer,
by diminishing the sole salve of redemption—collateral.
An Example
One of the very recent examples of this "new wave" of reinsurance movement
was the Lexington's so called sidecar reinsurance agreement with Concord Re.,
a newly formed Bermuda reinsurer where there will exist a pro rata agreement
covering the first $10 million of property contracts. Concord Re. will be funded
with $750 million, and undoubtedly will receive an A- rating, which appears
to be the standard of the majority of new reinsurance companies. Concord Re.
is yet another one of the significant increase of insurers to the island of
Bermuda, where the addition of surplus since Katrina is well in excess of $25
billion. This insurer is described as being one of the "special purpose vehicles"
(I love the connotation), whose sole business will be ceding insurance and reinsurance.
Then, to top off the breathless move toward this paradigm, we now have a
hedge deal running, where hurricane damage futures are taken by betting either
on individual storms or an entire hurricane season. This can be accomplished
either on an individual basis, or as a portfolio.
Where Is the Paradigm?
Can it be the unprecedented movement of huge amounts of investment offshore,
coupled with the incredible number of newly formed insurers and reinsurers,
all of whom are alien? You betcha! This, coupled with the expectation that those
doing business within our shores can expect a potential decrease in collateral,
and those offshore under a wide variety of regulatory statutes can conduct business
pretty much as they wish.
I'm not questioning the efficacy of the majority of these insurers, yet,
during the past decade, and especially half decade, how many of them have either
gotten themselves into serious financial difficulty or become insolvent and
gone to run-off? In short, where is the guarantee, by the reinsurer to the ceding
company for the payment of loss or return of profit margin, their financial
strength, their partners, their venture capital agreements, their owners?
A significant number of these insurers continue to espouse the theory that
they can underwrite property insurance, especially catastrophe cover. I've said
on numerous occasions, to the point of ad nauseam, that underwriting property
is at best a risky business. There is, realistically, no actuarial basis, and
the catastrophe models haven't been right once.
The Future
Where is this paradigm going? I do not believe anyone has an answer, I'm
not even sure that the participants have an answer, much less a long-term plan.
One thing is for sure, this unprecedented amount of venture capital and risk
moving to these insurers creates what can only be described as "risky business."
The answer is time, which (as usual) will cast the final answer.
By the way, for those of you who are involved in placing reinsurance, especially
offshore, I caution you to read the "Pay as Paid" wording, assuming it has been
made a part of the contract, which basically says that the reinsurer will not
pay any losses until they have been paid. There is nothing the matter with that,
except that many of these have an indemnity agreement which virtually absolves
the reinsurer from most any claim brought by the reinsured. On the assumption
that the reinsurer holds significant funds for whatever purpose, it would be
well to insist on a separate notional account (or trust) in the name of the
reinsured, with mutual agreement as to placement and use of funds to enhance
surplus.
Lastly, on a subject which is somewhat in line with this article, Congresswoman
Debbie Wasserman Schultz of Florida is leading House Bill 5891 to discuss and
attempt to find legitimate answers to the question of catastrophic loss. I wrote
Congresswoman Schultz, suggesting that governmental intervention is not necessarily
the answer. Our government is not the answer to every critical issue that we
as Americans face, especially with the insurance industry, which should have
sufficient intelligence and resolve to ascertain a legitimate way to handle
catastrophic occurrences—within the industry.
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