Presentation on theme: "THE ORIGINS OF THE CREDIT CRUNCH AND THE EMERGENCE OF A REINSURANCE CRUNCH Reinsurance Trends and Lessons to be learned from the Global Financial Crisis."— Presentation transcript:
THE ORIGINS OF THE CREDIT CRUNCH AND THE EMERGENCE OF A REINSURANCE CRUNCH Reinsurance Trends and Lessons to be learned from the Global Financial Crisis The African Perspective. Rajni Varia
We have witnessed the most difficult economic environment of the last 30 years Global GDP growth, real % p.a. Oil CrisisEarly 90s recession Dot- com bust Credit crunch Source:IMF
While there are many interlinked causes, they all centre around a very human failing: GREED USA household savings rate, %FTSE 100 Index We believed the good times would never stop Source:IMF, Yahoo Finance
In the housing market, we believed prices would rise forever, though experts warned us they were too high What caused this? UK House Prices, £ ‘000 1995200020052010 “[House prices in the ] United Kingdom… also still seem overvalued by most conventional measures “ IMF, September 2006 Source:UK Land Registry
A buyer who only considered the “guaranteed” returns and ignored the risks Wow! The Jones’ next door have made £100,000 on their house! I want some of that So we gave them… 110% loans to help those who couldn’t afford the down-payments Discounted mortgaged interest rates during the initial periods to help those who couldn’t afford the repayments Self-certified incomes to help those who didn’t have a regular income
A broker who didn’t care about the risks and just wanted to get the commission Well, we don’t actually lend you the money – a bank will do that – sow e don’t care if you repay the loan. We still get our commission. You guys are awesome! You are really willing to work with guys like me Wow! Lets get started
A bank that didn’t really carry or understand the risks they were selling US mortgage backed CDO outstanding, $ tn 9697980302012000049905060708 Source:SIFMA I’d better get rid of these crappy mortgage loans. They are starting to stink up my office. Thankfully the really smart guys in New York will buy them and perform their financial magic! I’ll call them right away New mortgage file
Investment banks that were too far from the customer to understand the risks Source:Realtytrac US properties with foreclosure activity, ‘000 Q4Q1 Q2 Q3Q4Q1Q2Q3 200720082009 Sure, individually these are pretty crappy loans, but if we pool them together, only some of them will go bad – certainly not all of them. And since house prices always go up, we really have nothing to worry about RSG Investment Bank of Wall Street “Trust the Really Smart Guys for all your investment needs”
So what happened? Investment bank can’t pay and goes under Banks stop lending Economy worsens and jobs are lost Customer can’t pay the mortgage Bank claims from investment bank The credit crunch is born
We all knew this. So what? Lets consider the African Insurance/Reinsurance market
We have brokers who are only interested in the commission Let me get this right... You get me cheaper premiums, extremely wide coverage, and even reimburse cost of hiring an expert who will help me maximise my claim. How can you afford this? We don’t actually cover the risks – an insurer does that and we still earn our commission Ace Insurance Brokers “We give you more for less” Wow! Lets get started then. You said i don't need to complete a proposal form!
We have underwriters looking for growth... I have brought you a new client.. I used our slip.... Please don't ask too many questions..no, there’s no proposal form- i know the risk.. Big Insurance Company “Your trusted and largest insurer” So we give them… 10% discounts Riders Extensions Delete all exclusions Extended payment terms A real case had 127 special clauses! If you do not want it,I have many more insurers waiting to take it … No problem, I will give you whatever you want….
The insurance company does not retain the risk.... Source:Realtytrac Net retention for selected insurers, as a percentage of gross retention I’d better get rid of these crappy risks. They are starting to stink up my office. Thankfully the really smart reinsurers will take them from me. I’ll call them right away Big Insurance Company “Your trusted and largest insurer” Poorly Rated Risks file A B C Average: 8.5% of gross retention D E F G H I J K L M N O
Reinsurer.. We need to support our clients and provide local capacity... Supersmart reinsurer of Africa “Trust the really smart guys” Sure the risks may look bad, but I’m sure we’ll make enough investment returns to cover our losses. Besides, we’ve grown our market share! Combined ratio for selected reinsurers, % 20062005200420072008 A B C
What are the trends? Worsening claims ratios Declining underwriting profits Inability to build up reserves to pay for future catastrophic claims. We must learn our lesson
? So what might happen next? Reinsurer can’t pay and goes under Insurance company can’t pay and goes under Rates rise, breaking circle? OR Capital flows in reducing rates again? Customer buys cheap insurance and maximise claims Insurance company passes the claims on to the reinsurer Will we break the cycle or perpetuate it?
Real Example of an All Risk Policy with “free” special clauses Sum insured: $40m Premium: $48,000 126 special clauses, increasing the scope of the policy, reducing protection for the insurer and encouraging moral hazard and bad behaviour on the part of the insured, for example Several clauses deleted (e.g., Electrical, Petrol and Mineral Oil Warranty) 85% average condition + 15% capital additions ie 30% in total Claim preparation costs Accidental error or omission/misdescription clause Stock declaration condition deleted Are adequate additional charges levied for these clauses?? I think not! MD BI (Profits + ICOW) Additional ICOW Claims preparation cost Loss adjustor fees & expenses Claim details $5.766m $3.056m $556k (12Xpremium) $37k (0.8Xpremium) $501k (10Xpremium) The insurers retained only 3.6% of the claim !
African Reinsurance Trends International Reinsurers are either withdrawing completely or reducing their support Major African Reinsurers are realising the need to pay greater attention to the bottom line as opposed to the top line We are learning our lesson- hopefully
Future survival - what the insurer needs to do Need to Return to the Basics-adhere to a code of ethics/underwriting: -The Insured, Insurer and Reinsurer must all have an interest and benefit from loss prevention/minimisation Check quality of Risk/ client Proposal forms Risk surveys Understand and clearly define scope of cover Proper Rating and pricing of Risks Adequate excess Pay attention to the Bottom line !
Future survival - what the reinsurer needs to do MUCH MORE STRINGENT APPROACH TO ENSURE PROFITABILITY AND LONG TERM SURVIVAL. Clearly specify the scope of cover provided Limit the automatic underwriting capacity Link commission to performance of the reinsurance contract Proportional treaties Increased priorities Technical pricing of working and catastrophe covers Non- proportional treaties !
Rating agencies have a mixed outlook for 2009 Changed outlook for Reinsurance Industry from stable to negative –”too much capacity without certainty of capital” (Global Reinsurance Industry outlook 2009) Changed from Stable to Negative - ”Reinsurers ability to replenish capital after a major loss in the present economic climate” a key concern (Global Reinsurance Review 2009) Maintaining a stable outlook in 2009 for the global reinsurance sector, which implies that the majority of 2009 reinsurer rating actions are likely to be affirmations, with only a modest number of anticipated rating or outlook changes (AM BEST-2009 Special Report: Global Reinsurance – Market Review. Reinsurers Stay Afloat in Sinking Economy“)
APPENDIX: Real life example of an all risks policy
23 Real Example of an All Risk Policy - special clauses Electrical clause deleted Petrol and Mineral Oil Warranty deleted 72 hours clause – including all natural perils, riots and strikes 85% average condition Accidental error or omission/Misdescription clause Adjoining buildings All other contents – US$ 20,000 Appraisement Clause – US$ 20,000 Architects, quantity surveyors and consulting engineers clause Automatic reinstatement of loss clause
24 Breach of warranties/conditions clause Bush fire Cancellation (30 days) clause Claims preparation clause – US$ 50,000 Cost of demolition/clearance of debris clause – US$ 50,000 Cost of re-erection clause Capital additions clause – 15% Definition of building clause Definition of property clause Fire Brigade clause (municipal or private)
25 Mortgage clause Lien clause Municipal scrutiny fees clause Public utilities clause Reinstatement of value clause – New for old Temporary removal (internal and external) Rent receivable, payable and rental value Contract price clause Computer system records clause Contract works – US$ 20,000
26 Cross liability clause General interest clause Goods in trust and /or commission Import Duty clause Landlord’s fixtures and fittings Other insurances clause Parked vehicles Payment on account clause Property of employees and visitors – US$ 5,000, in total Public Authorities clause
27 Riot, strike and civil commotion Spontaneous combustion Subrogation waiver clause Tenants clause either with the client as a tenant or the client as an owner Vehicle loads clause – US$ 10,000 Un-occupancy – 30 days Arbitration clause Stock declaration condition deleted Malicious Accountants clause
28 Fire protection/security installation in operative clause Joint venture clause Protection of property clause Disposal of salvage clause Supplier or Manufacturers guarantee or warranty Property in course of construction Protection of Manufacturer’s guarantee Functional unit clause Co-insurers to follow the leader
29 CLAUSES APPLICABLE TO SUB-LIMITS Machinery Breakdown Foundation /refractory brickwork Surrounding Properties Replacement Repairs Including Overtime, night work and expenses and airfreight Fundamental unit Expediting expenses 50% Additional/replacement machinery Replacement capacity conditions
30 Business Interruption Alternative basis clause Additional increase in cost of working Finds and penalties Business increase clause Forward exchange losses Hire in plant Departmental clause Interests on loss sales Loss of interests
31 Business Interruption (Cont) Suppliers extension Customer extension Prevention of access Public utilities Public telecommunication Accidental damage Payment on account
32 Money Definition of Money Clause Assault Clause/employees effects Deletion of keys clause Money held by employees/directors – US$ 2,000 Definition of transit – in transit Cash box extension Premium adjustable annually on actual annual carry
33 Money (Cont) Deletion of keys clause Fire, explosion, earthquake and all other special perils Infidelity of employees – 14 days Cancellation Notice – 30 days Including riot and strike Payment on account clause
34 Burglary Including hold up Including theft from the open – US$ 10,000 Including goods held in trust Cost of replacement of lost safe keys Payment on account clause
35 Electronic Equipment Damage by power surge/interruption damage External Data Media – US$ 10,000 Increased cost of working/hire costs Including fire, lightening, allied perils Including theft Including All Risks worldwide cover for movable equipment including but not limited to laptops and projectors Reinstatement of loss Replacement basis of cover
36 Electronic Equipment (Cont) Including expediting expenses Including temporary removal Replacement of basis of cover 72 hour clause of all natural perils and riot and strike 85% average condition Malicious damage Accidental error or omission Automatic reinstatement of loss clause Breach of warranties/conditions clause
37 Electronic Equipment (Cont) Cancellation (90 days) clause Claims preparation cost – US$ 2,000 Temporary removal (internal & external) Import duty clause Payment on account 75% clause Subrogation waiver clause Mechanical and electrical breakdown including power interruption and surge Portable/mobile equipment but excluding motor vehicles licensed for road use