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insurance companies. As such, a change in the mindset of consumers—and, to a lesser degree, regulators—may be necessary before reinsurers can realize their growth potential in these markets.


Other hurdles for reinsurers entering emerging markets are developing an adequate understanding of risk, navigating protectionist regulation, and finding locally qualified professionals. The limited history of insurance markets in these regions provides for limited actuarial data, and the data that are available may not be reliable because the nature of risk exposures evolves rapidly in emerging economies. For example, rapid property development can alter building characteristics (such as height and construction material, which influence their vulnerability to catastrophe perils) and concentrations of risk exposures. And the evolution of business, regulatory, or legal practices may alter business practices or behavior. The 2011 flood losses in Thailand exemplified some of these issues: A number of properties that Japanese manufacturers used in their supply chains were situated in flood zones, which led to underappreciated business-interruption risks that came to light only as losses were reported. Thus, outcomes are uncertain, and reinsurers who believe the diversification that emerging- market business offers justifies aggressively low pricing may lose sight of the risk in these markets.


Although New Zealand is not an emerging market, reinsurers’ recent experience there provides a good illustration of unforeseen risk in a “non-peak” catastrophe zone. The three earthquakes in 2010 and 2011 led to large surprise catastrophe losses from thinly priced business there, owing to limited understanding of earthquake risk due to unknown faults and the unanticipated governmental actions (such as condemnation of certain sections of land) that followed the quakes.


Despite these challenges, some global reinsurers have already benefited from international expansion, and opportunities in emerging markets remain considerable. Taken together, high economic growth and low insurance penetration in these areas point to large growth opportunities, but we believe such expansion still wouldn’t be sufficient to offset pressures closer to home—at least for now.


Looking Beyond The Numbers


Industry observers have focused on sharp and persistent declines in rates for excess-


Global Reinsurance Highlights 2014


Reinsurers may be loosening their terms and conditions in other lines of business as well. For example, multiyear treaties appear to be becoming more common, and broker reports have noted that reinsurers are now more willing to write excess-of-loss reinsurance on an excess casualty insurance book (insurance that only covers losses after coverage from the first-loss policy is fully exhausted), which introduces theoretically higher earnings volatility regardless of whether it is well priced.


“Although property catastrophe price drops are getting more headlines, the story isn’t much better for other lines of business.”


of-loss coverage, particularly in property catastrophe programs, with attention- grabbing drops as high as 25%. Pressure on ceding commissions is often noted too. But these numbers don’t tell the full story. Terms and conditions of reinsurance contracts may be loosening overall, and risk-adjusted rates don’t always adequately capture these changes, in our view. Many catastrophe contracts, for instance, are expanding their terms to include terrorism coverage, more-favorable reinstatement premiums, longer “hours” clauses (which determine the time period a set of events may be considered a single loss under the treaty), or multiyear coverage periods versus the more standard annual treaty. Although risk-adjusted pricing may reflect some of these factors, it may not properly quantify all of them.


Such loosening of terms and conditions, while currently limited, may be particularly dangerous because it can be hard to quantify and monitor—and because it may not have an immediate impact on profits, it’s a tempting way for underwriters to stay competitive. This trend could degrade underwriters’ discipline and risk management and allow them to evade scrutiny by regulators, investors, and possibly their own management. We view the potential for competitive pressures to push reinsurers to relax their risk management significantly as most worrisome because it would heighten the financial risk of those businesses and erode their credit quality.


And The Cycle Goes On


For players in the reinsurance industry, the current market dynamics are not surprising. Reinsurance markets are inherently cyclical, and given reinsurers’ flexibility to enter and then exit various markets, conditions on the ground can change rapidly. We’re not seeing any signs that reinsurers’ operating conditions will improve during the next two years. As pressures on the market build, reinsurers will need to work harder to maintain their profitability and competitive positions without compromising their risk profiles—and finding a strategy resilient enough to weather this trough in the market cycle will be a tall order. Should their efforts fail, certain reinsurance companies could be at risk of downgrades down the road.


Jason S Porter, CFA New York, (1) 212-438-3348 jason.porter@standardandpoors.com


Dennis P Sugrue


London, (44) 20-7176-7056 dennis.sugrue@standardandpoors.com


Taoufik Gharib


New York, (1) 212-438-7253 taoufik.gharib@standardandpoors.com


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