Tag Archives: underwriting expertise

Multiple Temptation

I thought it was time for a quick catch up on all things reinsurance and specialty insurance since my last post a year ago. At that time, it looked like the underlying rating environment was gaining momentum and a hoped-for return to underwriting profitability looked on the cards. Of course, since then, the big game changer has been COVID-19.

A quick catch-up on the 2019 results, as below, from the Aon Reinsurance Aggregate (ARA) results of selected firms illustrates the position as we entered this year. It is interesting to note that reserve releases have virtually dried up and the 2019 accident year excluding cats is around 96%.

The Willis Re subset of aggregate results is broadly similar to the ARA (although it contains a few more of the lesser players and some life reinsurers and excludes firms like Beazley and Hiscox) and it shows that on an underling basis (i.e. accident year with normalised cat load), the trend is still upwards and more rate improvement is needed to improve attritional loss ratios.

The breakdown of the pre-tax results of the ARA portfolio, as below, shows that investment returns and gains saved the day in 2019.

The ROE’s of the Willis portfolio when these gains were stripped out illustrates again how underwriting performance needs to improve.

Of course, COVID-19 has impacted the sector both in terms of actual realised losses (e.g. event cancellations) and with the cloud of uncertainty over reserves for multiple exposures yet to be fully realised. There remains much uncertainty in the sector about the exact size of the potential losses with industry estimates ranging widely. Swiss Re recently put the figure at between $50-80 billion. To date, firms have established reserves of just over $20 billion. One of the key uncertainties is the potential outcome of litigation around business interruption cover. The case brought in the UK by the FCA on behalf of policyholders hopes to expedite lengthy legal cases over the main policy wordings with an outcome expected in mid-September. Lloyds industry insurance loss estimate is within the Swiss Re range and their latest June estimate is shown below against other historical events.

I think Alex Maloney of Lancashire summarised the situation well when he said that “COVID-19 is an ongoing event and a loss which will take years to mature”, adding that for “the wider industry the first-party claims picture will not be clear until 2021”. Evan Greenberg of Chubb described the pandemic as a slow rolling global catastrophe impacting virtually all countries, unlike other natural catastrophes it has no geographic or time limits and the event continues as we speak” and predicted that “together the health and consequent economic crisis will likely produce the largest loss in insurance history, particularly considering its worldwide scope and how both sides of the balance sheet are ultimately impacted”.

The immediate impact of COVID-19 has been on rates with a significant acceleration of rate hardening across most lines of business, with some specialty lines such as certain D&O covers have seen massive increases of 50%+. Many firms are reporting H1 aggregate rate increases of between 10% to 15% across their diversified portfolios. Insurance rate increases over the coming months and reinsurance rates at the January renewals, assuming no material natural cats in H2 2020, will be the key test as to whether a true hard market has arrived. Some insurers are already talking about increasing their risk retentions and their PMLs for next year in response to reinsurance rate hardening.

Valuations in the sector have taken a hit as the graph below from Aon on stock performance shows.

Leaving the uncertainty around COVID-19 to one side, tangible book multiples amongst several of my favourite firms since this March 2018 post, most of whom have recently raised additional capital in anticipation of a broad hard market in specialty insurance and reinsurance market, look tempting, as below.

The question is, can you leave aside the impact of COVID-19? That question is worthy of some further research, particularly on the day that Hiscox increased their COVID-19 reserves from $150 million to $230 million and indicated a range of a £10 million to £250 million hit if the UK business interruption case went against them (the top of the range estimate would reduce NTAs by 9%).

Food for thought.

Creepy Things

It has been a while since I looked at the state of the reinsurance and specialty insurance markets. Recent market commentary and insurers’ narratives at recent results have suggested market rates are finally firming up, amidst talk of reserve releases drying up and loss creep on recent events.

Just yesterday, Bronek Masojada the CEO of Hiscox commented that “the market is in a better position than it has been for some time”. The Lancashire CEO Alex Maloney said he was “encouraged by the emerging evidence that the (re)insurance market is now experiencing the long-anticipated improvements in discipline and pricing”. The Chubb CEO Evan Greenberg said that “pricing continued to tighten in the quarter while spreading to more classes and segments of business, particularly in the U.S. and London wholesale market”.

A look at the historical breakdown of combined ratios in the Aon Benfield Aggregate portfolio from April (here) and Lloyds results below illustrate the downward trend in reserve releases in the market to the end of 2018. The exhibits also indicate the expense disadvantage that Lloyds continues to operate under (and the reason behind the recently announced modernisation drive).

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In the Willis Re mid-year report called “A Discerning Market” their CEO James Kent said “there are signs that the longstanding concern over the level of reserve redundancy in past year reserves is coming to fruition” and that in “some classes, there is a clear trend of worsening loss ratios in recent underwriting years due to a prolonged soft market and an increase in loss severity.

 In their H1 presentation, Hiscox had an exhibit that quantified some of the loss creep from recent losses, as below.

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The US Florida hurricane losses have been impacted by factors such as assignment of benefits (AOB) in litigated water claims and subsequently inflating repair costs. Typhoon Jebi losses have been impacted by overlapping losses and demand surge from Typhoon Trami, the Osaka earthquake and demand from Olympics construction. Arch CEO Marc Grandisson believes that the market missed the business interruption and contingent BI exposures in Jebi estimates.

The fact that catastrophic losses are unpredictable, even after the event, is no surprise to students of insurance history (this post on the history of Lloyds is a testament to unpredictability). Technology and advances in modelling techniques have unquestionably improved risk management in insurance in recent years. Notwithstanding these advances, uncertainty and the unknown should always be considered when model outputs such as probability of loss and expected loss are taken as a given in determining risk premium.

To get more insight into reserve trends, it’s worth taking a closer look at two firms that have historically shown healthy reserve releases – Partner Re and Beazley. From 2011 to 2016, Partner Re’s non-life business had an average reserve release of $675 million per year which fell to $450 million in 2017, and to $250 million in 2018. For H1 2019, that figure was $15 million of reserve strengthening. The exhibit below shows the trend with 2019 results estimated based upon being able to achieve reserve releases of $100 million for the year and assuming no major catastrophic claims in 2019. Despite the reduction in reserve releases, the firm has grown its non-life business by double digits in H1 2019 and claims it is “well-positioned to benefit from this improved margin environment”.

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Beazley is one of the best insurers operating from London with a long history of mixing innovation with a balanced portfolio. It has doubled its net tangible assets (NTA) per share over the past 10 years and trades today at a 2.7 multiple to NTA. Beazley is also predicting double digit growth due to an improving rating environment whilst predicting “the scale of the losses that we, in common with the broader market, have incurred over the past two years means that below average reserve releases will continue this year”.

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And that’s the rub. Although reserves are dwindling, rate improvements should help specialty (re)insurers to rebuild reserves and improve profitability back above its cost of capital, assuming normal catastrophe loss levels. However, market valuations, as reflected by the Aon Benfield price to book exhibit below, look like they have all that baked in already.

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And that’s a creepy thing.

Befuddled Lloyd’s

Lloyd’s of London always provides a fascinating insight into the London insurance market and beyond into the global specialty insurance market, as this previous post shows. It’s Chairman, Bruce Carnegie-Brown, commented in their 2017 annual report that he expects “2018 to be another challenging year for Lloyd’s and the Corporation continues to refine its strategy to address evolving market conditions”. Given the bulking up of many of its competitors through M&A, Willis recently called it a reinvigoration of the “big balance sheet” reinsurance model, Lloyd’s needs to get busy sharpening its competitive edge. In a blunter message Brown stressed that “the market’s 2017 results are proof, if any were needed, that business as usual is not sustainable”.

A looked at the past 15 years of underwriting results gives an indicator of current market trends since the underwriting quality control unit, called the Franchise Board, was introduced at the end of 2002 after the disastrous 1990’s for the 330-year-old institution.

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The trend of increasing non-CAT loss ratios after years of soft pricing coupled with declining prior year reserve releases is clear to see. That increases the pressure on the insurance sector to control expenses. To that end, Inga Beale, Lloyd’s CEO, is pushing modernisation via the London Market Target Operating Model programme hard, stating that electronic placement will be mandated, on a phased basis, “to speed up the adoption of the market’s modernisation programme, which will digitise processes, reduce unsustainable expense ratios, and make Lloyd’s more attractive to do business with”.

The need to reduce expenses in Lloyd’s is acute given its expense ratio is around 40% compared to around 30% for most of its competitors. Management at Lloyd’s promised to “make it cheaper and easier to write business at Lloyd’s, enabling profitable growth”. Although Lloyd’s has doubled its gross premium volumes over the past 15 years, the results over varying timeframes below, particularly the reducing underwriting margins, show the importance of stressing profitable growth and expense efficiencies for the future.

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A peer comparison of Lloyd’s results over the past 15 years illustrates further the need for the market to modernise, as below. Although the 2017 combined ratio for some of the peer groupings have yet to finalised and published (I will update the graph when they do so), the comparison indicates that Lloyd’s has been doing worse than its reinsurance and Bermudian peers in recent years. It is suspicious to see, along with the big reinsurers and Bermudians, Lloyd’s included Allianz, CNA, and Zurich (and excluded Mapfe) in their competitor group from 2017. If you can’t meet your target, just change the metric behind the target!

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A recent report from Aon Benfield shows the breakdown of the combined ratio for their peer portfolio of specialist insurers and reinsurers from 2006 to 2017, as below.

click to enlargeAon Benfield Aggregate Combined Ratio 2006 to 2017

So, besides strong competitors, increasing loss ratios and heavy expense loads, what does Lloyd’s have to worry about? Well, in common with many, Lloyd’s must contend with structural changes across the industry as a result of, in what Willis calls in their latest report, “the oversupply of capital” from investors in insurance linked securities (ILS) with a lower cost of capital, whereby the 2017 insured losses appears to have had “no impact upon appetite”, according to Willis.

I have posted many times, most recently here, on the impact ILS has had on property catastrophe pricing. The graph of the average multiple of coupon to expected loss on deals monitored by sector expert Artemis again illustrates the pricing trend. I have come up with another angle to tell the story, as per the graph below. I compared the Guy Carpenter rate on line (ROL) index for each year against an index of the annual change in the rolling 10-year average global catastrophe insured loss (which now stands at $66 billion for 2008-2017). Although it is somewhat unfair to compare a relative measure (the GC ROL index) against an absolute measure (change in average insured loss), it makes a point about the downward trend in property catastrophe reinsurance pricing in recent years, particularly when compared to the trend in catastrophic losses. To add potentially to the unfairness, I also included the rising volumes in the ILS sector, in an unsubtle finger point.

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Hilary Weaver, Lloyd’s CRO, recognises the danger and recently commented that “the new UK ILS regulation will, if anything, increase the already abundant supply of insurance capital” and “this is likely to mean that prices remain low for many risks, so we need to remain vigilant to ensure that the prices charged for them are proportionate to the risk”.

The impact extends beyond soft pricing and could impact Lloyd’s risk profile. The loss of high margin (albeit not as high as it once was) and low frequency/high severity business means that Lloyd’s will have to fish in an already crowded pond for less profitable and less volatile business. The combined ratios of Lloyd’s main business lines are shown below illustrating that all, except casualty, have had a rough 2017 amid competitive pressures and large losses.

As reinsurance business is commoditised further by ILS, in a prelude to an increase in machine/algorithm underwriting, Lloyd’s business will become less volatile and as a result less profitable. To illustrate, the lower graph below shows Lloyd’s historical weighted average combined ratio, using the 2017 business mix, versus the weighted average combined ratio excluding the reinsurance line. For 2003 to 2017, the result would be an increase in average combined ratio, from 95.8% to 96.5%, and a reduction in volatility, the standard deviation from 9.7% to 7%.

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To write off Lloyd’s however would be a big mistake. In my view, there remains an important role for a specialist marketplace for heterogeneous risks, where diverse underwriting expertise cannot be easily replicated by machines. Lloyd’s has shown its ability in the past to evolve and adapt, unfortunately however usually when it doesn’t have any choice. Hopefully, this legendary 330-year-old institution will get ahead of the game and dictate its own future. It will be interesting to watch.


Epilogue – Although this analogy has limitations, it occurs to me that the insurance sector is at a stage of evolution that the betting sector was at about a decade ago (my latest post on the sector is here). Traditional insurers, with over-sized expenses, operate like old traditional betting shops with paper slips and manual operations. The onset of online betting fundamentally changed the way business is transacted and, as a result, the structure of the industry. The upcoming digitalisation of the traditional insurance business will radically change the cost structure of the industry. Lloyd’s should look to the example of Betfair (see an old post on Betfair for more) as a means of digitalising the market platform and radically reducing costs.

Follow-on 28th April – Many thanks to Adam at InsuranceLinked for re-posting this post. A big welcome to new readers, I hope you will stick around and check out some other posts from this blog. I just came across this report from Oliver Wyam on the underwriter of the future that’s worth a read. They state that the “commercial and wholesale insurance marketplaces are undergoing radical change” and they “expect that today’s low-price environment will continue for the foreseeable future, continuing to put major pressure on cost“.