By MATTHEW BRODSKY, senior editor/Web editor of Risk & Insurance®
In the heady days after the March 11 Tohoku earthquake in Japan, reinsurance executives called into question one of the maxims of their business: that to spread the risk of their property-catastrophe book of business, they ought to diversify geographically.
Tohoku was just the accent mark on a litany of recent disasters around the globe that had been impacting international reinsurance: Chile's earthquake, New Zealand's two temblors, floods in Queensland, Australia, the winter storm Xynthia in Europe, to name but some of the bigger ones.
Diversification used to be the way to go, said Pina Albo, president of the Reinsurance Division of Munich Reinsurance America Inc., speaking at a March 31 reinsurance symposium put on by the Chartered Property Casualty Underwriters Society. But it's the strategy that's led firms to get hit in Chile, Australia, New Zealand and Japan, she said.
"These losses are reminders to everyone, that they're possible," she said.
You can call it "diworsification," kidded Bill O'Farrell, chief reinsurance officer for ACE Group.
As for property-catastrophe reinsurance, as a buyer of the product, said O'Farrell, also speaking at the spring CPCU Society event, he seeks to buy a global form of coverage. Reinsurers, on the other hand, try to sell "slices" of coverage for regions, such as Chile or Japan. O'Farrell said he hopes that Japan will teach reinsurers that this isn't the way to go, that in doing so reinsurers make their own lives difficult when they try to recoup losses in localized markets like Chile or New Zealand.
Diversification isn't new and has been around at least for a couple decades, said Bryon Ehrhart, chairman of Aon Benfield Analytics and chief strategy officer of Aon Benfield.
"Reinsurers have written this stuff forever," he told Risk & Insurance® by phone, regarding international property risks.
Typically, he said, reinsurers' core exposures in the United States and Europe drive their capital needs, so when they write internationally, it doesn't seem to require that much more capital.
"That's just how the math works," he said.
And as for the slices of coverage O'Farrell mentioned, that's nothing new either. One reason reinsurance buyers might call for a "global" program, Ehrhart said, is for the ease of it. Yet while they're buying these slices, they tend to patch together a global program that's cheaper and has higher limits than if they bought one big global reinsurance program. That's because the technical price is much lower for local policies outside of the United States and Europe, and because with each individual policy, cedents get an original limit and a reinstatement limit.
So, his ultimate point is that while folks might have been grumbling about diversification after Japan, the markets shouldn't expect practices to change.
"Reinsurers by and large have taken the long-term view," he said, meaning that they accept that "unfortunate events" will happen internationally but that the overall idea behind the strategy still makes sense.
Ultimately, this was the conclusion the reinsurance professionals at the CPCU Society meeting arrived at.
"I think diversification is key to a successful organization," said John Bender, chief operations officer at Allied World Reinsurance Co.
And Munich Re's Albo, who wondered aloud first about the strategy, agreed that well-done diversification is a good thing.
Ah, yes, the qualifier "well-done," is one about which Karen Clark, CEO and founder of the Boston-based catastrophe risk consulting that bears her name, has something to say. "Diversification is a very good strategy," she said. "In theory, it is the right strategy."
Theory and reality diverge, however, for a couple of reasons. First, reinsurers have a "false sense of security" about diversification because of the way they appraise their risk. Reinsurers have a very sophisticated process to figure out what the optimal book of business is for them, but one shortcoming is an overreliance on catastrophe models. These tools fail to capture a "high percentage" of low-frequency, high-severity events, particularly in many parts of the globe where the scientific knowledge and data collection about catastrophes are wanting, Clark said.
Another reason, Clark said, is that some reinsurers may want diversification a little too much, so much so that they are willing to price risks lower than they would if the risks were stand-alone. In areas of the world where the primary insurance market isn't as developed, rates may be suppressed further because there's simply more supply of reinsurance than demand, Clark said.
"How much do you want to write of this underpriced risk just to get diversification?" she said.
June 1, 2011
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