Casualty Reinsurance Experts Warn of Terms of Entanglement

As risks stretch across an entire reinsurance portfolio, it's easier for one risk to affect another unrelated risk in another part of the portfolio.

By CYRIL TUOHY, managing editor

If there's a silver lining in a property-catastrophe risk, it's that the risks are relatively cut and dried and the numbers--while at times staggering--are fairly clear. Reinsurers may not be happy about receiving a property-catastrophe claim in the mail, but at least it's the kind of claim they can prepare for.

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Contrast that to the casualty-catastrophe risk, which make reinsurers shudder. The casualty CAT claim is nebulous and very likely to be far more expensive than first thought. It's the kind of claim reinsurers have trouble preparing for and it's the claim that may well push reinsurance rates up in the future, according to experts.

"There is often no geographical reference with which to anchor risk management strategies, and the implications may be felt around the world," noted the reinsurance broker Guy Carpenter in an August report titled "Casualty CAT Unveils Hidden Risks in Your Portfolio."

The good news is that casualty-catastrophe risks tend not to repeat themselves. Enron's energy market manipulations, for example, aren't likely to repeat themselves. Hurricanes, by contrast, tend to follow similar patterns.

Losses related to casualty CAT tend to have a much longer tail, according to Nicholas C. Frankland, CEO of Guy Carpenter & Co.'s European operations. The subprime crisis is a case in point. He called this class of casualty CAT risk "entangled risks" with implications as important as property-CAT risks because they cut across the entire risk portfolio.

He also cited the rising number of class-action lawsuits in Europe as an example of a casualty CAT risk with the potential to entangle other areas of a reinsurer's portfolio. "It's harder to manage risk in isolation than it ever has in the past," he said.

Case in point: A construction company faces class-action suits against its directors and officers for overestimating development costs and projected rental income. Surveyors, marketers, lawyers and accountants, all of whom have provided ancillary services to the company, are now involved in the litigation, according to Guy Carpenter.

Even the computer software company finds itself entangled in the dispute as it may have misrepresented the nature of the payments made using its accounting software. Thus, there's a direct risk to the carrier providing errors and omission coverage for the initial project, and insurers writing directors and officers coverage for any company, however tangentially related, could wind up paying on the claims. These exposures eventually make their way upstream to reinsurers.

The risk to casualty reinsurers, according to Guy Carpenter CEO Peter Zaffino, has become more complex and "multifaceted," than in the past. Risk management programs, for example, have to take into account the cost of lawsuits along with the capital allocations of a company, and the potential effects of a casualty CAT risk on earnings.

For now, reinsurance prices are expected to continue to soften, and that's great news for primary insurers looking to renew contracts on January 1. Cedants laying off their risk onto reinsurers will either pay less, or if they pay about the same, can expect better terms.

But reinsurers want to be sure their clients have been warned: casualty CAT risks are bubbling and when they surface, there will likely be hell to pay.

November 1, 2008

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