Insurers and reinsurance industry bosses should be thinking about their New Year’s resolutions. They will probably go something like this:

• I will instruct my underwriters to increase premium rates
• I will make sure my company achieves a technical profit across the board
• I will try to invest risk free
• I will initiate a root-and-branch programme of enterprise risk management, investing in whatever systems and people are necessary to make it work.

OK, I made that last one up.

But the industry is certainly going to press for rate increases come the January 1 renewal. It doesn’t have an option.

The reasons for such resolve are clear. Insurers and reinsurers have so far proved resilient to the problems besetting other financial institutions. But they need to be very sure footed if they are going to stay resilient over the medium to long term.

They’re not in as bad shape as banks, but insurers and reinsurers are still looking at depleted capital bases and minimal investment yields in the future. Their financial flexibility is constrained and no-one is sure how long this three dimensional crisis will last. An increase in claims activity caused by recession, a credit crunch with legs and a stock market correction all happening simultaneously? Not even the most seasoned industry bosses have seen that before.

In a presentation in London earlier this month, Swiss Re’s chief US economist Kurt Karl said if there is one thing he is certain about it’s this: the uncertainty will continue.

At least let’s be grateful that we are not in the banking business was the message from Karl and his Swiss Re counterpart, Thomas Hess. Insurance is fundamentally different to banking: you can’t have a run on an insurance company because payouts are not triggered by policyholders’ will; insurance hazards are uncorrelated and there is no contagion between insurers; and insurers are not exposed to short term fluctuations in asset values because they usually hold them to maturity.

Mr Hess acknowledged that the industry’s double whammy of reduced investment yield and hurricane-related underwriting losses had eaten into the industry’s solvency ratio. But he pointed out that it is still 20% better than the low figure recorded in 2002. “Insurers and reinsurers coped with that [ratio] in 2002 so that cushion still exists,” he said, before adding. “But it all depends on what happens ahead.”

Rating agency Standard & Poor’s agrees that reinsurers have sufficient excess capital available to absorb the shocks of 2008 (including windstorm losses), but its credit analysts point out that the cushion has lost much of its stuffing. According to their analysis, the combination of hurricanes Gustav and Ike and the impact of investment losses for the first nine months of 2008, adds up to around $22bn of capital erosion for nine of the largest global reinsurers.

S&P says that this ‘AAA stress’ has effectively wiped out 85% of the excess capital held by that same group of reinsurers, on the basis that they had a total of $25.4bn at the beginning of the year.

If that doesn’t concentrate everybody’s minds on underwriting for a profit, I don’t know what will. How about the possibility of a major nat cat event blasting up the US east coast sometime next year? Enter Aon Benfield’s climate Cassandras.

The Aon Benfield UCL Hazard Research Centre boffins are predicting an active Atlantic hurricane season in 2009. In their news release they ask readers to note that their long range forecasts do not have a great record. But, based on current and projected climate signals, US landfalling hurricane activity will be 35% above the 1950-2008 norm they reckon.

So volatile weather and an inclement investment climate: uncertainties persist on either side of the balance sheet. That’s not good news for an industry sitting uncomfortably on a rather thin cushion. If the wind does blow, capital markets investors willing to help reload the industry will be in short supply, unlike previous years.

(Re)insurance industry CEOs are not well known for their resolve. This time it is different: they know they need to protect their capital position and they know how to do it.

Tags: Renewals

This entry was posted by Garry Booth on Friday, December 19th, 2008 at 9:09 am and is filed under Insurance Commentary.