Reckoning for Reinsurers After the Financial Storm
Insurance Networking News, January 1, 2009
Never has the world of reinsurance been faced with as many pressures as it is today. Start with legacy issues such as mold or asbestos, add emerging exposures such as nanotechnology or climate change, throw in a pinch of regulatory issues such as Solvency II and, of course, stir in the economic condition and the impact on the overall insurance industry. What you end up with is definitely not a piece of cake.
Years of soft market conditions followed by sudden and sharp hardening periods, tremendous losses from man-made and natural catastrophes and open-ended liabilities such as nanotechnology and terrorism are putting severe pressure on reinsurers.
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The market is hardening in the reinsurance sector or, at least, the soft market has bottomed out. Whether rates rise in January 2009 or 2010, reinsurers expect an increased demand for reinsurance, and hope to increase rates by at least 10% or more in certain lines at the January 1 renewal. While some reinsurers may shield themselves from negative cash flow by renewing the book with minimal increases, by 2010, market rates will have to go up as capital is scarce. Although most insurers and reinsurers have experienced few direct hits from sub prime mortgage investments, the subsequent fall in stock markets has prompted write downs, and has depleted investment income at insurers, gobbling significant portions of their equity capital.
Karlyn Carnahan
Post crunch, fundamental issues will be examined. In the United States, a perceived failure of risk management, control and supervision despite SOX may lead to an increased scrutiny on risk controls, leading to even more stringent capital and liquidity requirements. And in Europe, Solvency II, scheduled for a 2012 implementation date (at press time), requires utilization of data from a broad range of sources to measure and monitor risks driving a risk-based economic framework, including risk-based capital requirements. Firms will need proper processes in place for identifying and quantifying their risks in a coherent framework.
In an increasingly complex, interlocked and fast-moving world, where should a reinsurer best deploy capital in their IT investments? Like primary insurers, reinsurers are experiencing what Novarica terms the "frostbite effect" in IT strategy. Reinsurers are pulling in from the edges to protect their core capabilities to remain viable and competitive in a challenging market. These core areas are data and modeling, compliance and control, and operational efficiencies.
DATA AND MODELING CAPABILITIES
We all know you can't model everything, and modeling certainly isn't a perfect science. Who would have thought that Hurricane Ike not only would go through Texas, but create storm surges clear up to Ohio? But with these kinds of changing exposures underway, use of catastrophe models is critical to price and manage catastrophe or event excess-of-loss reinsurance.
With any kind of modeling or analysis, the output is only as good as the data input into the model. At the end of the day, those reinsurers who focus on data capture, data accuracy and data completeness not only improve their own profitability, but also prepare themselves for increased scrutiny of their own books as increased regulation looms on the horizon. Reinsurers need to obtain more complete and accurate data from primary carriers, focus on data cleansing, and continue to utilize sophisticated analytical tools to find new opportunities for creating competitive advantage.
COMPLIANCE AND CONTROL
Whether a reinsurer is likely to be directly impacted by Solvency II or not, increased scrutiny from regulators is coming. Improved data collection and the ability to utilize that data is a key initiative most reinsurers will need to continue to improve in order to meet regulatory standards.
Reinsurer IT groups should collaborate with risk management and finance departments to proactively prepare for more frequent data calls asking for more detailed levels of data to assure compliance with new risk based capital requirements. They should look toward initiatives focused on data integration, analysis and modeling. For some, new reporting or accounting systems will be warranted to create data availability, and to improve the efficiency of auditing.
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