Yemisi Izuora/Agency Report
The insurance industry is heading into a perfect storm and is kidding itself that current market conditions can continue, according to a leading London market grandee, Stephen Catlin.
Other experts speaking at an AM Best event in the UK capital warned insurance buyers that service levels may fall as a result of recent market consolidation.
Mr Catlin, Executive Deputy Chairman of XL Group, told delegates that a number of factors are currently at play that could result in the erosion of insurer capital.
“In my view we are in a very unstable situation,” Mr Catlin told delegates at AM Best’s European Insurance Market Briefing. “Yet we continue to kid ourselves of where we are at,” he said.
Mr Catlin painted a picture of today’s competitive insurance market, noting that it faces the prospect of increased losses, lower reserve releases and continued low investment returns.
He noted that catastrophe losses and large losses in the past two years were 40 percent of the run rate of the last ten years.
“To think that this can continue is to be in cloud cuckoo land,” he said.
In addition to catastrophe losses, Mr Catlin predicted that attritional claims, having been stable for the past four years, will also rise.
“Is risk management and claims management really that much better? I doubt if that is so. I expect we will see attritional losses rise in the next few years,” he said.
Mr Catlin also believes that positive prior-year reserve developments, which have boosted insurer profits in recent years, are coming to an end. He noted that reserves held against more recent years have held firm, or required strengthening.
“We are walking into a situation where combined ratios can go from 95% to 105%, even to 120%, in a very short space of time. Surplus capital could be eroded very quickly indeed and some say that we are close to a perfect storm,” Mr Catlin told delegates.
“This is realism not gloom, and we can do something about it,” he added.
According to Stefan Holzberger, Chief Ratings Officer at AM Best, Mr Catlin is ‘on the money’. But policyholders should not be unduly concerned, he said.
“There is a perfect storm, but it is around the performance of the insurance industry in coming years, and not from a credit perspective,” according to Mr Holzberger.
“The industry is well capitalised, but when we look forward there are many pressures on earnings and the ability of the market to maintain today’s high levels of capitalisation,” he said.
“It is a good time to be an insurance buyer-insurance companies are struggling to maintain their top line and are looking to strengthen their partnerships with insurance buyers in any way they can,” Mr Holzberger told CRE.
One consequence of market conditions has been increased mergers and acquisitions, which have included the merger of XL Group with Catlin, the specialty insurer established at Lloyd’s by Mr Catlin.
Mr Catlin predicted more mergers and acquisitions as insurers with global ambitions seek the benefits of size and cost efficiencies.
“There is a place for regional and specialty players, but if you aspire to be global then size does become an issue, because one of the drivers is the issue of expenses,” he said.
Mr Catlin believes that the combined XL Catlin has a ‘better chance’ of getting expenses under control in a ‘falling market’ where it is difficult to increase premiums.
However, the majority of mergers and acquisitions are not successful, according to Mr Catlin.
He believes that around two-thirds of M&As fail and are ‘shareholder decretive’ owing to problems with integration or the underestimation of reserves. The need to bolster reserves can double the cost of an acquisition, he said.
“Mergers are hard work and are not risk free,” Mr Catlin told delegates in London.
Mr Holzberger noted that smaller and mid-sized insurers are most vulnerable to current market pressures, and therefore more susceptible to consolidation.
He warned insurance buyers of the perils of market consolidation. Service can be hit, he said.
“If I were a risk manager of a large corporate, in the context of M&A, I would be concerned with service. If an insurer is undergoing a merger, you have to ask if they will maintain a focus on clients as they integrate underwriting and claims teams,” he said.
Mr Catlin believes that the combined group of XL Catlin is now relevant in the US and London market, but is still working on growth in Europe and emerging markets.
“We are working on being relevant in Europe, Asia Pacific, Latin America, Africa and eastern Europe. We are not quite there yet but we are closer together that we were apart,” he said.
Mr Catlin was also critical of Europe’s new capital and risk management rules for insurers, Solvency II.
“When first envisaged, Solvency II was a great concept, but unfortunately it has moved away from where it should be,” he said.
“Regulation is important, but it has to be fit for purpose and reflect the risks of the insurance industry, and not those of banks,” he said.