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The Bouquet Has Wilted

Michael Gertsch, chief underwriting officer at Gulf Re, bemoans the downward spiral created by the undercutting of terms and conditions to grow premium volumes.

The concept of placing various reinsurance treaties as a bouquet with obligations to participate across all lines is not unique to our region. It was, in fact, common practice in the early stages of all developed markets, be it the US, Europe or the UK. The industry was growing and everyone was happy. Until it all went horribly wrong.

In a growing economy there is a need for supporting lines of business that have an increased loss activity to enable the industry to develop appropriate practices and standards that would, over time, improve the performance of such risks. This works in the beginning as premiums are set accordingly to cover for the increased frequency of events. The result of such contracts, however, is very volatile and in order to secure continuous support more profitable accounts have to be brought into the negotiations to smooth the results for the reinsurers.

As risk management improves, the loss frequency reduces and prices start to fall, therefore increasing the volatility of the bouquet result by reducing the profit margin of the better-performing treaties. As long as the economy keeps growing exponentially, individual large losses can be off-set by the year over year growth across the portfolio. But what happens when the economy slows down or even stalls?

One would expect that the pricing for under performing insurance contracts would be corrected and deductibles increased to maintain a certain large loss loading. Unfortunately the exact opposite is happening. In order to be able to pay for the losses that will incur on the business written in the past year, insurers and reinsurers need to further grow their premium volumes. In an economic slow-down where organic growth is limited at best, this can only be achieved by undercutting terms and conditions even more to lure clients away from the competition. In an environment where all the companies are trying to apply that model, the downwards spiral starts spinning faster and faster. More risk with less return. It’s like surfing in front of a wave – no matter how good you are at it, at some point it will catch up with you.

Cash-flow underwriting is a risky way to manage a portfolio even when interest rates are high, but with the current performance of the financial markets it is simply impossible. We already see insurance tenders for “prestigious” accounts being won on terms and conditions that are not supported by the reinsurance markets. Insurers, therefore, have to either foot part of the bill themselves if they need full reinsurance protection or opt for introducing loss limits and retaining the remaining exposures net.

Instead of creating economic value and growth, the industry destroys capital at a rate that will ultimately force shareholders to take drastic actions by either down-sizing their operations or selling them. This usually leaves the door wide open for large international insurers that profit from enough diversification across their portfolios to balance these effects and become the dominant parties at a time when the underlying business will start to improve. Do we really want that? Times are changing and the industry needs to change with it if we want the region to become a self dependant and sustainably growing market place.