Insurance Day - Market facing testing time in 2006

Last year was a dramatic 12 months for the insurance industry, as the impact of the Spitzer investigation rippled through the sector and hurricane Katrina became the largest insured loss of all time. These events have brought new challenges for the industry, and below key industry figures reveal that 2006 promises to be just as dramatic as the market fights to meet December’s deadline for contract certainty before inception. 04 January 2006

ID: Will Katrina change the way cat risk is insured and modelled in the future?

Conor Finn: Katrina was a market defining moment. Underwriters need to fully review their aggregation controls, reassess their pricing and appetite for risk and get back to basics. In 2004 we had the luxury of assuming that the storms were aberrations. After 2005 we have to assume they are the norm. We have to plan our catastrophe underwriting and accumulation strategies accordingly to ensure we can maintain profitability despite high catastrophe activity.

Toby Foster: Until we have a clearer picture on the reinsurance treaty protections, it’s still too early to say what the full impact the 2005 hurricanes in the US will have on catastrophe risk.

However, next year’s Atlantic hurricane season has already been predicted as potentially aggressive by Tropical Storm Risk.

Risk modelling will continue to grow in prominence, as it’s been proven to be an effective tool for companies and insurers in measuring hurricane risk.

Simon Sperryn: In the short term, no. The insurance market has coped conspicuously well with these record losses and Lloyd’s and the London market specialises in this type of business.

In the long term, however, there is now increasing debate about trends in extreme weather conditions. Governments will be lucky if they escape from political pressure for a back-up level of state protection.

Michel Lies: Yes, it is definitely a signalling event for the whole industry. The fact that insurance enables economies to grow by protecting the industry from the economic effects of natural and man-made perils will become more prevalent again. Companies will need more protection for their balance sheets, and we expect that the market demand for catastrophe cover will increase.

In terms of modelling, the market has already adjusted the storm frequency in its models to reflect present climate variability, and the rating agencies have defined higher capital requirements for peak exposures. Swiss Re has also implemented a newly developed rating tool for US flood and storm surge in order to reflect these risks more adequately in our pricing. We believe that a solid exposure analysis will become even more important for any player in this field and may well lead to higher protection levels purchased in the future.

ID: How should the London market go about achieving contract certainty, and will this be possible by the end of December 2006?

Conor Finn: Contract certainty needs to become an integral and essential part of our business process and most, if not all, of the people I speak to agree that it is a critical issue that needs to be addressed. It would be difficult to find another industry when, at the point of purchase, the client is not always certain what he has bought.

I now truly believe that there is sufficient motivation, amongst the professionals within the London market, to ensure that contract certainty is achieved by the deadline of December 2006. If we, as a market, cannot raise our game then shame on us; our clients have many options available to them and if we do not provide a top quality service then we will lose business.

The market needs to see where it can standardise coverages so that during the underwriting process we only have to consider the differences and not the whole product offering. Once a high level of standardisation in coverage is achieved, we will be well on our way to achieving contract certainty.

Toby Foster: We would not presume to speak on behalf of others in the market, but for ourselves we are embedding the necessary processes and systems, accompanied by appropriate training, to ensure contract certainty is achieved for our clients in 2006. I do believe that, just as was achieved in the technology community, collaboration among competitors on non competitive areas - such as back office process and trading platforms - will lead to far greater innovation and value creation for clients, and better margins for the market participants.

We regard contract certainty as a core competency of the insurance industry. Fundamental to the value of insurance is the promise to pay valid claims in a full and timely manner. Certainty of contract is the best guarantee of that promise.

Conversely, if clients do not believe that their valid claims will be paid in a full and timely fashion, then the value proposition of the product is diminished.

Simon Sperryn: Success will depend on two things. Within each insurer and broker, contract certainty demands new behaviour and systems. At market level, we need agreements and protocols about what we can expect from each other, because in a subscription market we sink or swim together.

We will be assessed by the FSA on both these dimensions - they will expect managing agents and brokers to convince them that they’re in control of the delivery of contract certainty.

ID: What should be the main focus of the industry in 2006?

Conor Finn: During 2006 the market as a whole needs to focus on using technology to improve our back up and data capture, It’s about time the London market moved into the current century and stopped its over reliance on out dated paper intensive systems.

Toby Foster: Any broker that wishes to remain competitive and successful in 2006 must develop and implement a fully client-focussed approach, built round the fundamentals of transparency, efficiency and value.

By placing these fundamentals at the heart of their organisations, businesses will create a virtuous circle of innovation and value generation for clients. Our people are the key and leaders must be able to properly articulate the opportunities ahead, and move people past the perceived frustration of having to deal with additional regulation.

Simon Sperryn: On the trading floor, the market is struggling to find its new level following the catastrophe losses of 2005. On the one hand substantial losses need to be recovered while on the other hand, there is an increase of capacity flowing in to the market globally.

In the back office, the primary focus must be on achieving contract certainty.

Michel Lies: A key challenge is for pricing to reflect the current more active hurricane period in the North Atlantic as well as other catastrophe risks. There is absolutely no room for a softening of rates or terms and conditions. Swiss Re will adhere to strict underwriting principles and believes that the market as a whole will pursue a similar strategy. Also, the activity in cat bonds will increase in 2006 since there has been a growth in demand.

Another big challenge for the industry is the underwriting of European motor business. In France, UK and Germany for example, prices for motor insurance have come under pressure while at the same time medical and long-term health care costs as well as compensation awards for pain and suffering are rising. If these price wars continue at the current level of intensity underwriting losses in this line of business will once again become a distinct possibility. Swiss Re has already indicated that it would strive to be even more selective in providing underwriting capacity, calling on cedents to introduce risk-adequate pricing structures.

THE RESPONDENTS:

Conor Finn is managing Director of the non-marine property division at Markel International

Toby Foster is chief executive of UK retail at Marsh

Simon Sperryn is chief executive of the Lloyd’s Market Association

Michel Lies is executive board member and head of client markets at Swiss Re