08 July 2010

Catastrophes Wanted: Climate Change and the Soft Market in Reinsurance

At the moment the property and casualty insurance industry is awash in capital -- so much so that it is making it difficult to make strong profits because the excess capital exerts a downward pressure on the pricing of coverage. This situation is what is known as a "soft market."

Last month, National Underwriter described the situation as follows:
With $100 billion in excess capital, the property and casualty insurance market is not turning, a Wall Street analyst said Thursday, and a carrier executive attributed existing conditions to the absence of AIGs historical price leadership.

The analyst, Jay Gelb, managing director of Barclays Capital, speaking Thursday at the S&P Insurance Conference held here, said the commercial lines and reinsurance markets will be soft for at least several years barring major catastrophe losses, or some other type of shock to industry capital.

Thats because the p&c insurers are overcapitalized. Its as simple as that, Mr. Gelb said.

It make strike some people outside the industry as odd, but what the reinsurance market needs is a big catastrophe, maybe even two:

Thomas Motamed, chairman and chief executive officer of Chicago-based CNA, gauged the impact of catastrophes on a market turn.

He said brokers often tell him that a catastrophe is needed to end the soft market.

They believe that will drive the market turn, [but] I dont believe that for a second, he said.

The big companies with strong balance sheets can afford to take some hits, he explained, adding that the best companies are well-capitalized—much larger than they were a decade ago, when a single catastrophe may have changed the market.

How about two catastrophes? he asked rhetorically.

These are companies that make $1 billion or $2 billion a year. What you would need is multiple events, he said, postulating a natural catastrophe, an accompanying financial crisis and perhaps a terrorist event.”

He suggested that a more important factor relevant to insurance pricing changes is what happens with the economy.

Until the economy gets better, people are not going to pay us more for the product, Mr. Motamed said.

In the context of the soft market, some in the reinsurance industry are looking for a justification to try to firm up the market, to justify increasing premiums. If the economics don't justify increasing rates, maybe there is some other justification? Here is an Australian Broadcasting Corporation interview with a representative from Munich Reinsurance:

"Climate change, we believe, is a fact."


His pockets are already hurting.

"Based on our own loss experience, climate change we believe is a fact. It triggers natural disasters, atmospheric natural disasters, and the number of these natural disasters worldwide has more than doubled since the 1980s, driven by atmospheric perils, not by earthquakes or volcanic eruptions," Mr Rauch said.

"If we look at the sheer number of losses from natural catastrophes worldwide since the 1980s, more than $US1,600 billion in losses have occured. Most of them were actually weather-related, not earthquakes, not geophysical events."

And he says the economic cost of these disasters, once you take out things like inflation and currency fluctuations, is increasing by 11 per cent a year.

So faced with these increasing losses, what are large insurers and reinsurers doing?

Well, they're putting up premiums of course.

Well, they are at least trying to put up premiums. But in the marketplace, it is difficult to use science to argue against the economics of the market. And the market says that reinsurers have plenty of excess capacity and losses have not been at all unreasonable in recent years, so the market is soft. Of course, it is especially difficult to use science to argue against economics when that science is just wrong.

Climate change is indeed real -- with a significant human component -- but to date, there has been no signal of human caused climate change in the disaster record. Don't just take my word for it, you can see that result in the peer reviewed research conducted by . . . Munich Re.