How will the shifting reinsurance landscape affect the ART market?

The imminent deregistration as an approved reinsurer and closure of its non-life South African office by a major international reinsurer has given rise to some interesting debate in the local insurance market, which extends beyond the issue of shrinking capacity.

There is no question that globally the financial services industry, including the reinsurance sector, is being forced to ‘tighten its belt’. In the wake of the financial crisis, many reinsurers’ ratings have been downgraded and the cost of stable security (A- upwards) is considerable. Following significant losses in 2008, some reinsurers have been forced to re-evaluate their strategic criteria in order to return to a profitability level in line with shareholders’ expectations. This realignment has in some cases lead to wide scale reorganisation of reinsurers’ structures and the markets that they operate in. Unfortunately, the South African insurance market is relatively small in global terms and return on investment is typically relatively stable, albeit unexciting when viewed against possible returns from the US or Japan. Thus SA insurers must compete and perform at a higher level in order to attract the limited capital and reinsurance capacity available today.

Thus, if the local offices of international reinsurers want to be allowed by their parent companies to remain in this country, they will be required to take a far stricter approach to underwriting profits and operational efficiency. For the ART market, this translates to higher risk pricing and improved underwriting process and information management; resulting in an increased focus on risk management and risk financing by corporate clients. In 2008, the SA insurance market generally experienced poor loss ratios in the corporate property, motor and aviation markets. This has resulted in rates being increased substantially (fire between 10% to 15%, and motor between 17% and 18%). While the first quarter of 2009 has seen some improvement, the corporate property portfolio remains under pressure with continuing large losses affecting underwriting performance. This means that reinsurers will continue to seek higher risk prices going forward and there will be downward pressure on the treaty terms enjoyed by insurers in this market. Already reinsurers are no longer giving discounts where the loss ratio exceeds 50% and are also imposing net deductibles of between 10% and 15%, which historically were between 1.5% and 3%.

The big question facing the industry now is: will other international reinsurers also be departing our shores, leaving the South African market with reinsurance ‘servicing offices’, merely processing applications and renewals for cover, and referring decisions abroad?

While technology would certainly make this possible – some may even say feasible – the close, face-to-face relationships that local insurers have built with their reinsurance counterparts would suffer. Quite simply, reinsurance is one of those markets in which a thorough understanding of the client (insurer) and its markets are essential. In fact, as the financial crisis bites ever deeper, reinsurers are becoming more involved in the management of alternative risk transfer (ART) vehicles than they ever have been before, concerning themselves with areas where they were never previously involved. So, not only is it now a lot harder to find reinsurance capacity in the local market, it comes with an increased administrative burden for ART facilities. Reinsurers are adopting a far more hands on approach: requesting a constant flow of information on a monthly or, at the very least, quarterly basis so that they can have a closer understanding of how ART vehicles are being managed.

Undoubtedly one of the most serious consequences of reinsurers not having a meaningful (read: decision making) presence in the country will be the gulf that it could potentially create between the local market and the reinsurers. It will be extremely difficult to get them to understand the local market, not to mention the fact that maintaining long distance relationships is costly and difficult.

But it’s not all doom and gloom: the pending registration of a large French reinsurance group sends a positive message to the local market. And the flexibility inherent in the ART market still holds appeal for reinsurers. Some reinsurers are offering ART ‘deals’ whereby they have a standard 12 month treaty in place but want a guarantee that they will be the lead on the treaty for a minimum of three to five years. The lead share may reduce on an annual basis, however, they will still have the largest share on the programme. Generally, reinsurers do not want to offer ART facilities like cell captives capacity in year one when there is risk that the reinsurer could possible lose money. After a year the client may have enough money in the cell to no longer need reinsurance support and it is here that the reinsurer is saying ‘we will take the risk but we also want to see the up side’.

In fact, the ART environment creates the opportunity for true partnerships between reinsurers and ART providers. Reinsurers are increasingly encouraging ART facility owners to take on more risk, so both the facility owner and the reinsurer share the risk and reap the rewards.

The ART industry is well placed to rise to the challenge of providing all stakeholders with returns that are greater than other potential markets on a sustainable and long-term basis because it is, after all, founded on the basic premise of sound risk management, with facility owners truly sharing in the risk through stringent capital participation.

Having said all of this, one could also view the shifting reinsurance landscape as a proactive step in anticipating the advent of financial condition reporting (FCR) whereby the current distinction between ‘approved’ and ‘non-approved’ reinsurers could fall away.

One could also argue that reinsurance is inherently an international business and, in future, whether international reinsurers have a local incorporated office will matter far less than the security they provide. One could even question whether or not the business model of large general reinsurers can be competitive in today’s dynamic reinsurance environment.

Which ever side of the argument you sit on: there is no doubt that the shortage of capacity worldwide (and the increased cost of capacity when it can be found – especially capacity with well rated paper) will force larger corporates to self insure more, which augurs well for the alternative risk transfer market in these uncertain times.

For further information please contact:
Herman Schoeman, MD of Guardrisk
Telephone: 011 669-1001

Prepared  by:
Melanie Davis, PR@Work
Telephone: 011 615-3309 / 083 225 7450