Thinking the Unthinkable?
In 2011, according to Munich Re, the insurance industry paid over US$ 100 billion in natural catastrophes and extreme events. It was not much earlier (2005) that a similar amount was paid out for similar claims. 2011 topped it, causing the Geneva Association to dub the year, “Annus Horribilis”. Blame it on global warming if you will (but, also, do not under-estimate the human factor as a major cause of loss) the cyclicality of extreme insurance payouts is becoming shorter and the spend progressively higher.
The above is an economic market reality. Faced with this reality it is comforting to note that the insurance industry globally is meeting its financial obligations. However it also poses a few serious questions such as, “is the insurance pot for extreme events being replenished?” or “Are current pricing models adequate to meet both the year-on-year attritional losses and also set aside money for extreme events?”
Certain markets such as the MENA markets, perhaps due to their perpetually emerging nature and the constant interest of new reinsurance entrants, are conducive to retail pricing in constant freefall. One of my perennial arguments is that the primary MENA insurance region is not competitive. It is aggressive; but it is not competitive. Competition follows an economic rationale; price aggression doesn’t.
One suspects that, although pricing in the aggregate seems to be covering attritional claims, in some cases (particularly the Takaful companies in UAE among others) are eating into their capital and more reputable reinsurers are pulling back. The commercial rationale of a larger international reinsurer generally encompasses both long term technical profitability as well as commercial viability (the latter of which is generally although not necessarily dictated by portfolio size). Consequently, by default – all other things being equal – they would set their scope on the larger primary market players. Therefore, when the larger reinsurers start pulling away (and not without reason) from the larger or older primary market players in UAE or within the region, this is a clear indication that something somewhere is amiss. And, as long as the rest of the market continues like a herd to emulate the market leaders by top-line, then it is safe to state that something is wrong with the whole market.
All know that practices such as bouquet reinsurance placements and excessive use of proportional reinsurance are the morphine that continue to fuel the addiction. As long as there are reinsurers willing to supply it there will be primary market insurers willing to buy it and to abuse it. Then when the proverbial hits the fan the larger reinsurers find themselves reeling from anything between two to ten hits from as many treaties; but arising out of one loss which has been insured and reinsured into multiple proportional treaties within the region. The ultimate losers are also the original culprits, that is, the reinsurers supplying morphine to the market. But they are not the only culprits. It is shallow excuse by an insurance company to state that it bought capacity simply because it was available. It is an argument that possibly makes sense in the short-run but does not hold water in the long run.
Some insurance companies consistently paid relatively high double digit dividend over the years (in one case immediately before the crisis one UAE insurance company even paid a 100% dividend!). If we look at one of the top 3 UAE insurance companies any one of them could have paid in excess of AED 0.25 billion in dividends over the last five years or so. That is more than double the capital requirement to establish a general insurance company in UAE. A portion of that can also be the basis of reserve fund on which the primary insurer can start molding a healthy non proportional reinsurance programme on which coded, working and/or aggregate excess of loss programmes can be designed; oil for the lamps in case the unthinkable happens.
Mainly following the crisis insurers, as institutional investors, ceased being investment market makers and became price takers like every other participant in the investment market. This hinders the generation of long term funds or wealth for the industry. This also continues to put more pressure on the ‘here and now’ and casts a doubt on the economical viability of such companies in the region if faced by extreme events. The answer by many to the question of extreme events is that, “the region is not prone to them.”
Oil for the Lamps
Saying that the region is not prone to extreme events is tantamount to an ostrich mentality of burying one’s head in the sand. Hurricane Gonu did happen. Floods in Oman have also become an almost annual occurrence. Riot, civil commotion, sabotage and terrorism in Bahrain, Lebanon, Egypt and other countries in the region are also a reality. Earthquake tremors in Iran suggest that the region is not earthquake-free. Oil exploration and sea transport also suggest that the region is not free from major hull or pollution losses. It might be a only be matter of time before the unthinkable happens. An extreme event in the region is not an “unknown unknown”. It is a known unknown. The rapid development of infrastructure in the form of towers, highways, airports, free zones, metro lines and much more only serves to accentuate the potential magnitude of a possible extreme loss.
The possibility of a significant loss exists. Accumulation also presents us with aggregated severity across lines of business.
So these questions remain: Do we continue to bury our heads in the sand? Or do we start building the necessary reserves? Will we redesign our reinsurance treaties to make our companies more resilient and to also add more wealth to the company in the long run rather than pay dividends in the short run? Will we continue to play an “all tactics, no strategy” game or will we stand up and be counted perhaps at an initial (possibly personal) short-run cost?
Reinsurers are not in the business of subsidizing losses in one region by gains from another. Well, not continuously and in the long run at least. To do that would be tantamount to aiding and abetting moral hazard. Of that there is already a lot in the regional market.
The Other End of the Spectrum
A client’s problem is not insurance. A client’s problem is risk. The solution, or the emphasis, therefore should not be on cheaper premiums but on risk mitigation or resilience in the face of risk. Current market behaviour is not conducive to building this culture.
Insurers have a duty towards their client to provide them with long term value and not with a ‘quick fix’. We have an obligation to interact more with the real stakeholders and less with the finance or procurement officers. Although they belong to the same entity, the client, they do not necessarily speak the same language.
To expect a uniform approach by the market, i.e. companies walking away from unsustainable business propositions, is unrealistic. There will always be cowboys in the Wild West. To expect that a regulator micro-manages the technical activity of an insurer is also unrealistic.
But there will be beacon companies in the market that will stand for value and will walk away from prices in freefall even at short term cost. There are insurance clients in the market that have the wisdom and the foresight to choose value over price. This has to be sought out by insurance companies and acknowledged.
What will be happening in the future is that major reinsurers will reward primary market players who walk the talk and who stand for value. Major reinsurers will assist primary market insurers to design sustainable reinsurance programmes which add wealth to the companies and cement relations in the long run. Times are changing.