Unknown territory

The ReInsurer talks to Phil Sandercox, managing director at Cincinnati Re, about Covid-19 and the insurability of pandemics, and casualty market dynamics…

How far are we from getting a full understanding of ultimate industry losses from Covid-19 and how confident are you in the way your cedants are assessing and reserving for potential exposures?

Covid-19 remains an event “in progress”. On the property side, key coverage questions are in the hands of the courts and the progress of those cases will determine how long it takes for us to gain an understanding of industry losses. While many leading indicators on the liability side are positive, we have to keep in mind that any resurgence has a number of implications – from broad economic issues to insurance-specific coverage to claim frequency and severity issues, which are difficult to predict. For professional liability (other than healthcare) the concern has more to do with what happens following a recession than with losses directly linked to Covid.

Overall, we are pleased with how our clients are addressing Covid-19 within their portfolios. Certainly, there is room for debate regarding the degree to which exposure exists in given lines of business, coverages and attachment points, but in a vast majority of cases we think underwriters agree that pandemics are not insurable and are taking steps to ensure the clarity of their positions.

Can pandemic risks be fully modelled and insurable, and what role should reinsurers play in providing muchneeded solutions to address future events?

The short answer is “no”, pandemics are not insurable. By their very nature, pandemics do not align with several important underpinnings of the insurance mechanism. First, insurance is designed to respond to losses that are independent and limited in size, meaning that losses do not happen all at once and individual losses are not so severe that they threaten to bankrupt the insurer. Second, the loss must be calculable or at least estimable. We need two elements for this: probability of loss and the attendant cost. Lastly, loss must take place at a known time, in a known place and from a known cause. Pandemics are not specific to a time and place and therefore not aligned well with a definition of “event”. Losses from pandemics are extremely challenging if not impossible to estimate and the sheer size and correlation of potential losses threaten the solvency of the insurance industry.

How has the pandemic impacted your working practices and does it hinder your ability to assess risk when underwriting?

While we have a core group of associates who work from our headquarters, the majority of our team already worked remotely around the country where our brokers and clients are located, including Boston, Connecticut, Philadelphia, New York, Minneapolis and Seattle. Pre-Covid we gathered in person to regularly discuss plans, review results, design and test infrastructure and build our culture. We have had to make some adjustments to virtual collaboration, but for the most part our internal operations have run smoothly and uninterrupted.

The casualty question…

What areas of your book are seeing the biggest price increases on the underlying business and why?

The term “rate change” is complex to define and difficult to measure given the number of factors one can consider – and as a reinsurer we are in the role of accepting others’ definitions and measurements. With that as context, we have observed the biggest price increases in public company D&O, commercial automobile and excess casualty. The reasons that these lines of business are experiencing the most pricing pressure include:

At this stage, I think most carriers are struggling to fully identify the depth of the underwriting holes created during the 2014-2018 accident years, so there is an element of the landscape shifting as one fix has to be rolled out on top of an earlier one.

With strong pricing coming through on quota shares, can cede commissions be left as they are, or do loss trends mean that terms have to improve further?

Ceding commissions have evolved from a concept of reimbursement for expenses incurred in producing and underwriting business, to a fee for access to business.

However, if ultimate loss ratios are higher than expected and there has been an imbalance in the relationship, the only lever reinsurers have to address results in a QS is the ceding commission. When that happens, it makes sense that ceding commissions will come down until the reinsurers reach indicated results that pay them for the risk assumed. We think downward pressure on ceding commissions from reinsurers will continue. Rate increases and balanced ceding commissions are the tools reinsurers have to drive improvement in indicated returns. Additionally, the low interest rate environment – that’s hanging on longer than many anticipated – increases pressure on reinsurers to achieve lower combined ratios.

What impact is the low interest rate environment having on the underwriting of casualty risk?

Given the inherent uncertainty in underwriting casualty reinsurance and the persistently low interest rates since the great recession, reinsurers can only write transactions when they see attractive nominal risk-adjusted returns. With extremely low interest rates persisting for the foreseeable future, we expect additional pressure both on the primary and reinsurance side to focus on underwriting margin.

Do you expect to see increased demand from cedants for solutions to cap reserve deterioration on recent accident years?

Yes, after going through an extended soft market, which may have included undetected social inflation and a significant increase in severity, many company reserves could be inadequate. Consider commercial auto. It’s taken almost 10 years for the market to adjust to changes (distracted driving/ social inflation, etc.). If companies announce inadequate reserves quarter after quarter, investors and regulators may penalize them. I believe that reinsurance covers that transfer and finalize a company’s loss reserves will be in demand. Additionally, there is an opportunity cost element to having your leaders’ attention focused on issues from the past vs looking forward. The prospect of closing off prior year concerns is a tool to help leaders focus on issues they can control.