Terrorism Risk Highlighted at OECD Meeting by Guy Carpenter’s Director of Reinsurance Market Management, Chris Klein
Guy Carpenter’s Director of Reinsurance Market Management, Chris Klein, spoke at a recent Organization of Economic Cooperation and Development meeting focusing on terrorism. Guy Carpenter’s (re)insurance industry report “Terrorism — Reinsurers Standing By,” was released in conjunction with the meeting. He presented a wide-ranging overview of how the reinsurance industry weathered the recent global financial crisis.
Nearly all reinsurers experienced capital stress during the crisis. Their balance sheets suffered far greater damage due to asset volatility than they did from underwriting losses. Asset impairment trends unfolded in 2008, as evidenced by the level of shareholders’ funds tracked in the Guy Carpenter Reinsurance Composite, which declined by 18 percent during 2008.
With reinsurer asset levels almost completely recovered in 2009, the troubles of the financial crisis appeared to be receding. Not surprisingly, prices were down at the January 1 and April 1, 2010 renewals. However, the first quarter of 2010 has been challenging with catastrophe losses from events in excess of USD250 million totaling approximately USD17 billion in the first quarter of 2010 compared with USD7 billion in the first quarter of 2009. These losses still do not appear to have absorbed excess capital or driven price increases. But, estimates of the cost of the Deep Water Horizon rig in the Gulf of Mexico are rising. There are also concerns about several recent aviation losses along with early signs of potential heightened hurricane activity in the North Atlantic.
As the terrorism threat has evolved, the (re)insurance industry has reacted and adapted. The terror reinsurance market has changed significantly since 2001. Activity and pricing levels have generally fallen since the peak that occurred following the attacks of September 11, 2001 due to the absence of a major loss and supply/demand imbalances. Regional differences exist, however, with activity in the United States clearly down while other markets have remained steady.
A recent Guy Carpenter & Company, LLC survey of reinsurance underwriters improved our understanding of the terrorism reinsurance market. The findings were consistent with our beliefs and offered additional insights that are significant and encouraging:
- More than 80 percent of reinsurers are actively seeking new or expanded terror insurance transactions, emphasizing the imbalance between supply/demand in the marketplace
- Purchases of standalone terrorism covers have decreased over time largely due to pricing disconnects and lower perception of product need
- Reinsurers prefer geographically discrete opportunities
- Two-thirds of markets are offering cover for nuclear, biological, chemical or radiological events, demonstrating a true evolution in underwriting appetite from the period following the September 11, 2001 attacks.
Governmental pools play an important role in the terror reinsurance market by providing insurers with a safety net for their exposures. Large reinsurance placements are usually behind these pools.
The possibility of the capital markets assuming terrorism risk through catastrophe bonds securities remains a possibility. They have the advantage of spreading the risk to the broader financial markets, and because they are collateralized, credit risk is neutralized.
So where does the reinsurance market stand today? In the short term supply exceeds demand and the pressure on pricing is downwards with some local exceptions such as South American earthquake and aviation. Repatriation of capital to shareholders and some consolidation are also symptoms of this excess capacity.
In the medium term, we think reinsurers’ earnings will be under pressure from low investment returns, diminishing support from prior-year loss reserve releases, rising inflation and higher regulatory capital requirements, especially in Europe. In theory, this should lead to higher prices as reinsurers try to cover their rising cost of capital and make a margin.
Meanwhile, reinsurers tend to allocate fixed amounts of capacity to terror risks and gear it less aggressively than natural catastrophe allocations. Consequently, should a major attack occur or even the serious threat of an attack emerge, capacity could be depleted very quickly. In such situations, those insurers that have already begun to explore reinsurance options may be better placed to secure the cover they need in a tightening marketplace.