March 28th, 2012

What to Watch in 2012, Part I

Posted at 1:00 AM ET

Opportunities Amid Uncertainty in the Year Ahead

2012 will undoubtedly be a challenging year, but Guy Carpenter believes that growth opportunities exist - or can be created - for companies that have the fortitude to see and develop them. Below we examine 10 major themes that the (re)insurance sector will face in 2012.

Theme #1: Aggregate Covers

Theme #2: Cat Model Changes

Theme #3: Tightening Reserves

Theme #4: Rating Agency Assertiveness

Theme #5: Solvency II

Theme #6: Dodd-Frank Act

Theme #7: FASB - IASB Reconciliation

Theme #8: Lloyd’s of London - Positioning for the Future

Theme #9: Cyber-Risk

Theme #10: Cold Spots

Theme #1: Aggregate Covers

“Basket cover,” “Top and Drop” and “Whole Account Aggregate Stop Loss” aggregate covers are an effective way to protect against severe shock losses and horizontal coverage. Insurers can fill in the gaps with aggregate covers.

Following the increased frequency of major catastrophic events witnessed in 2010 and 2011, many companies are revisiting the benefits of aggregate coverage. Aggregate coverage has long been a consistent offering in the reinsurance market as it is a solution that focuses on mitigating the impact of frequency of loss on results. While much of the focus for catastrophe coverage is around severe shock losses, aggregates are also useful for horizontal coverage needs or a combination of frequency and severity.

Theme #2: Cat Model Changes

Understanding and achieving the right blend of cat models (both vendor and proprietary) can be a “make or break” in terms of predicting cat losses. However, understanding changes and choosing the right model can be a challenging task for insurers as each modeling firm has its own sense of style and peculiarities.

Catastrophe models are essential in assessing risk exposure and have become must-have tools for any (re)insurer underwriting catastrophe loss coverage. In recent years they have evolved from useful supplemental tools to forces in their own right. As the changes in RMS v11 become more fully implemented in 2012, the impact on companies’ probable maximum losses (PMLs) will continue throughout the year. Guy Carpenter, therefore, recommends adopting a multiple catastrophe model approach so as to better estimate risk and control uncertainty.

Theme #3: Tightening Reserves

Insurers have been “sticking their hands in the financial cookie jar” for the past few years by releasing reserves to help boost financials. The time may have come where the jar is empty with significant implications for sector profits and capital growth.

In recent years, reserve releases have helped support financial results in the face of a weakening market and significant catastrophe losses. Guy Carpenter’s expectation is that the P&C industry still has some releases left. The industry may start to see deteriorating reserves in 2013 or beyond. However, for some carriers that write specific lines, like workers compensation, reserve deterioration may come sooner. Heading into 2012, Guy Carpenter’s analysis of the reserving cycle suggests that the industry is about to enter a new, challenging phase of reserve deterioration.

Theme #4: Rating Agency Assertiveness

There’s an old saying in financial markets: ‘Rating agencies are always right, even when they’re wrong.’ Rating agencies have become more active in 2010 and 2011, both in terms of sovereign and carrier actions. This has significant implications both for reinsurance buyers and for reinsurers.

2012 looks set to be a year of potential mixed fortunes for reinsurers, and this may be reflected in their ratings. Following the S&P action to place a number of companies and groups on CreditWatch negative in December, a number of reinsurers are highlighted as having a good chance of being downgraded. Companies with deteriorating loss estimates and reserve deficiency could find themselves under pressure by the ratings agencies. Conversely, those companies that have navigated 2011’s rough waters with their capital and earnings relatively intact, and that can provide evidence of their ability to take advantage of improving industry conditions, may be in a position to target improved ratings.

Theme #5: Solvency II

The path to Solvency II has been a long and winding road. It nevertheless remains essential for insurers to ensure they are taking the right route or capital and operational gridlock could ensue. Staying informed of updates is crucial.

The date of Solvency II implementation had been set at January 1, 2013. However, because of some recalibration work and a legislative process required at both the European and national levels, it is believed the introduction of Solvency II will be postponed until January 1, 2014. The delay has led to indecision for some companies around how to proceed. Concerns also exist with regards to Solvency II equivalency in Asia Pacific.

Tomorrow on GC Capital Ideas: Themes 6 through 10

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