RSK Review Podcast
David Flandro, MD of Hyperion X, discusses the state of the insurance and reinsurance markets with Gert Cruywagen, arguing that, although the sector is robust, innovation is needed.
The global insurance market, like the global economy, is currently in disarray, but it is still too early to quantify the losses emerging from the pandemic in full. Finding a point of comparison is tricky, but the Covid-19 crisis has more in common with the liability crisis caused by asbestosis claims than catastrophic disasters like Hurricane Katrina. Asbestos and environmental exposures occurred in the post-war era leading up to the 1990s and beyond. The claims affected long-tail lines, especially workers’ compensation, as large numbers of people contracted cancer and other illnesses. The claims were far greater than expected and the industry had paid out around $300 billion dollars in 2005. It was a multi-year loss and was technically the largest the industry has suffered in modern times, in real terms. We don’t yet know if the pandemic will lead to bigger losses, but it doesn’t help that it struck during a financial and economic crisis. Both investment performance and underwriting have taken a hit.
The last time the sector was in true distress was after Hurricanes Katrina, Rita, and Wilma when there was a broad dearth of capital and multiple smaller insurers and reinsurers went into run-off. That includes 2011 (Daiichi Fukushima) and 2017 (Hurricanes Harvey, Irma, and Maria). Every earnings statement I have looked at recently has been revised downwards. We’re losing premium, earnings and balance sheet assets, and capital in the sector is decreasing. On the liability side, we are seeing some large reinsurance losses.
Having said that, it’s important to note that, going into this crisis, the insurance and reinsurance sectors were both very well capitalised. We estimate that the reinsurance sector had about $400 billion in capital, and the insurance sector had trillions of dollars, much of that excess. We can withstand and absorb even quite significant losses. In 2017, we were looking at a $150 billion loss and there were arguments about claims development pursuant to the hurricanes that year, but the sector’s capitalisation was not impaired. We can trade through this, provided we all honour contract law.
How the pandemic may affect the future of the industry
Most insurance carriers have excluded business interruption, although there are exceptions, and some have been exposed to property losses, compensation, and D&O claims, for example. This raises the question of how pandemics should be underwritten in the future. If companies are subject to rate filing regimes, will regional governments force them to pay extra contractual claims, or will they be tied up in the courts for years contesting those claims? Will some risks be so large that they are uninsurable, and will insurance companies ask for government back-stops, like the Terrorism Risk Insurance Act (TRIA) after 9/11, which became the Terrorism Risk Insurance Program Reauthorization Act (TRIPRA), or Pool Re? It may depend upon which claims are paid or made to be paid. Will these be extra-contractual, ex gratia or per contract? Will a government facility be set up to facilitate underwriting pandemic losses? We are in a state of flux and are still assessing the losses experienced in the first and second quarters of the year, but we do know that risk premiums will likely rise, as they do in times of uncertainty. At the same time, a recession could reduce demand, which could lower prices over time. We could also see capital impairment, which may decrease supply.
We may need to look at the industry line by line. For example, motor vehicle claims are down in developed economies because of lockdown, and on a backwards-looking basis we may see a profitability spike for motor insurance priced in. On a forward-looking basis, people may simply drive less because they are working from home and buying fewer cars. This longer-term secular trend may be unfavourable for motor pricing.
Developing resilience in the sector
Clearly, having better risk management than others will differentiate companies in future. To ensure that underwriters will want to do business with you, be sure to use technology to quantify your exposure in a more intelligent way. Create a safer working environment for your employees and have contingency plans in place.
Intermediaries need to be more efficient. Acquisition cost ratios have risen to above 30% over the past 15 years, but technology can be used to lower costs, especially in the wholesale market, and with following capacity. The aim is ultimately to lower the price of coverage for individuals and businesses coming out of the crisis. Brokers really can be part of the solution in this landscape. We are in an environment where brokers and underwriters should work closely together to create products. When there is a dearth of capital or a decrease in capacity, innovation can save the day.
We are currently offering stop-loss insurance cover that is collateralised and based on a calendar year loss ratio trigger, with capital markets as the counterparty. Our rate is competitive with subordinated debt, and cheaper than equity issuance. This product has not been available in the reinsurance market, but there is a demand for it, given changing market dynamics.
If you are selling insurance, what is key is lowering acquisition costs, creating better products for our clients, bringing capital to market, and finding ways to be part of the solution. If you are buying insurance, it is important to use technology to quantify your risk. Prove to underwriters that you are a good risk, even if you must change your business practices, and demand products that fit your needs.
- David Flandro is MD of Hyperion X, the data and analytics specialist unit of the Hyperion Insurance Group. It uses technology and disruptive innovation to create better data, analytics, and service for clients.