January 29th, 2009

Clash Renewal Stable, Interest Renewed

Posted at 1:00 AM ET

Nick Olijslager, Managing Director

Casualty clash reinsurance rates increased by 1.1 percent on average at the January 1, 2009 renewal. Specific layers renewed at rates of -12.3 percent to 17.5 percent, based on program-specific factors such as loss history and changes to limits and retentions. Casualty clash remains a relatively small market, but many larger carriers are showing a renewed interest in this product, especially those with larger net lines of business.

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The vast majority of programs (70 percent) either renewed at expiring terms or were able to secure rate decreases relative to 2008. Forty-five percent of programs were able to secure rate decreases year-over-year, with another 25 percent renewing at expiring terms. Only 30 percent of programs sustained price increases at the January 1, 2009 renewal.

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Most renewing programs made no changes to their retentions or limits. Only 6 percent increased retentions, and 23 percent lowered them. Some carriers increased clash retentions as part of a broader trend involving other lines of business, while others did so because of loss activity. Fifteen percent of renewing programs moved for higher limits, while only 8 percent went in the opposite direction.

Changes to Retentions
No change: 72 percent
Increase: 6 percent
Decrease: 23 percent

Changes to Limits
No change: 77 percent
Increase: 15 percent
Decrease: 8 percent

Overall, the casualty clash reinsurance market remained stable year-over-year-in terms of retentions, limits, and reinsurance rates. Since few large carriers purchase this form of coverage, capacity was sufficient and relatively insulated from the effects of the global financial catastrophe. The availability of capital was increased by the participation of property-catastrophe markets interested in diversifying into non-accumulating lines of business.

The Casualty Catastrophe Threat

While the casualty clash and catastrophe risk has become prominent in recent years, it is a threat that casualty writers have faced for decades. Casualty catastrophes have been frequent and severe since October 19, 1987, when the Dow Jones Industrial Average lost 22.6 percent of its value. High profile events since “Black Monday” include the initial public offering (IPO) laddering typically associated with the “dotcom bubble” and the equity analyst scandal that followed; accounting debacles involving Enron, WorldCom, Adelphia, and others; and, of course, the ongoing financial catastrophe which began with the collapse of the subprime mortgage market.

Each of these events destroyed immense amounts of shareholder wealth and led to economic damages exceeding those of the most severe property catastrophes. Last year alone, insured catastrophe losses reached USD50 billion worldwide, while the financial crisis is estimated to have an economic impact of above USD1 trillion. The implications of what would appear to be a contained event spread rapidly via the normal business relationships required to participate in a global and interconnected economy. Joint ventures, partnerships, and supply chain linkages transmit liability alongside operational efficiency. As a result, one event has the potential to trigger a chain reaction of losses across a casualty insurer’s portfolio, affecting multiple lines of business and many insureds.

Traditional risk management techniques are not equipped to address casualty catastrophes. Professional and product liability coverage tend to focus on specific circumstances. The possibility that liability could spread (e.g., along a supply chain) is concealed by the complexity of contemporary commerce. Carriers thus are exposed to large risks which remain unhedged … and often unknown.

Magnified Implications

The broadened exposure that comes from a casualty catastrophe is only one aspect of how this peril can have a disproportionate impact on carrier balance sheets. Losses of capital (on the balance sheet) can extend to earnings (income statement), ultimately reducing the firm’s value. Even a loss that a carrier is sufficiently capitalized to absorb could drag the company’s overall value lower.

A large insurer, for example, could sustain an insured loss of USD100 million without necessarily seeing surplus decline. Yet, earnings would be noticed, which likely would lead to a market value loss that is a multiple of earnings. Carriers with higher price-to-earnings ratios (P/Es) stand to lose more market value in the event of an earnings impairment. Further, a larger hit to earnings is likely to magnify the multiple.

Over the past year, insurers have sustained losses on both sides of the balance sheet, with asset-side impairment generally seen as a driver behind the increasing cost of capital. While these implications should not be ignored, analysts tend to take a harder stance on liability losses. After all, disproportionate liability losses would signal ineffective insurance risk management, a carrier’s necessary core competency.

What Is Clash Cover?

Casualty clash and catastrophe cover may seem exotic, but the underlying mechanism is straightforward. Quite simply, clash cover consists of a per occurrence excess of loss (XOL) reinsurance contract. This vehicle protects an insurer from losses related to a specific event that would affect several insureds or lines of business.

Casualty Clash: losses involving multiple policies or insureds

Casualty Catastrophe: no limit to the number of risks involved in the same loss

More than a dozen markets domiciled in the United States and Bermuda offer clash reinsurance cover. A typical market covering clash will have capacity of up to USD100 million, while it is possible that sources of capital can offer much more.

Large national carriers showed fresh interest in clash cover at the January 1, 2009 renewal, after several years of not having secured much protection. Product availability, terms, and pricing led to the downward trend in purchasing. Now that many of these cedents are considering larger net lines on their portfolios (and capacity is certainly available in the marketplace), casualty carriers are beginning to secure the appropriate protection.

Keep Cats at Bay in 2009

A new generation of modeling tools has been developed to track the diffuse implications of Casualty catastrophes and clash risk throughout a carrier’s portfolio. Guy Carpenter’s Casualty Cat model, developed jointly with Arium, Ltd., offers risk accumulation profiles and a disaster scenario inventory that enable risk managers to gauge the true extents of their exposures. Risk can be traced form a root cause to the other industries and geographies that could be affected, and casualty writers can make informed risk management decisions.

Casualty Cat facilitates the study of single- and multi-peril casualty catastrophe risks in an insurer’s broader risk management plan. Through a rigorous analysis of inter-industry trading and supply chain data, carriers can assess key vulnerabilities, providing a foundation for risk transfer planning and execution. The model measures risk and impact by proximity to cause. Based on the spread of an event’s implications across industry and coverage lines, a risk accumulation profile is developed, showing a portfolio’s exposures and providing a starting point for risk mitigation planning.

Using techniques grounded in network theory, Casualty Cat maps various scenario outcomes throughout a carrier’s portfolio by highlighting the links among the insureds. Carriers can use metrics such as the insureds’ policy limits and premiums to estimate losses, assess relative vulnerabilities, and assign risk loads - along with other portfolio management tasks. No longer concealed, casualty catastrophe risks become knowable and therefore manageable. Casualty Cat enables risk-bearers to take action.

While Casualty Cat makes the domino effect from the original trigger seem intuitive, the threats derived from the cause are not readily discernable on their own. A carrier would have to devise a scenario, trace the implications through a vast network, and hope that nothing is missed. A scenario could be overlooked, or an implication may not be captured. As this relatively straightforward example shows, complexity arises quickly.

Using Casualty Cat to explore the risks to a casualty carrier’s portfolio, it is possible to construct and implement a thorough risk management plan. If a casualty catastrophe does strike, the protection afforded by the Casualty Cat-supported plan should prevent balance sheet damage and, in the extreme, loss of shareholder value. Of course, the carrier will be able to improve capital management as a result of more informed decision-making.

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