Financial crisis hits reinsurers

Cayman Islands homeowners could face higher property insurance premiums next year because of the way the US financial crisis has affected reinsurance companies.

Nigel Twohey

Mr. Twohey

Two of Cayman’s insurance executives from Sagicor General Insurance (Cayman) Ltd. – President Danny Scott and Senior Vice President Michael Gayle – visited the company’s European reinsurers late in September to start the negotiations for the renewal of their reinsurance treaties.

The news they heard was not good. Reinsurers are worried about their capital base, Mr. Gayle said.

‘Whereas it is still too early to say what the actual impact will be, it is apparent that the reinsurance industry has suffered significant losses to its capital base as a result of the crisis in the US financial markets,’ he said.

‘We met with more than a dozen reinsurers and almost without exception, there was concern and uncertainty regarding the impact on their own balance sheets and the balance sheets of the reinsurance market as a whole.’

Reinsurance capacity, and therefore price structure, is often impacted by natural disasters such as hurricanes and earthquakes.

Hurricane Gustav and particularly Hurricane Ike created large insurance claims in the Caribbean and the US Gulf Coast. However, the financial crisis could create a much larger loss to reinsurers, Mr. Gayle said.

‘One leading reinsurer referred to the crisis as a ‘Category 6 storm’,’ Mr. Gayle said. ‘It appears likely that the impact of this [financial] crisis could well be more severe than the impact of [the hurricanes].’

Sub-prime connection?

Cayman Islands Insurance Association President Nigel Twohey said investment income is extremely important for the financial strength of reinsurance companies.

With the plunge of the US stock market in recent weeks, reinsures lost significant investment assets.

‘This is the main area where reinsurers have been hit,’ he said. ‘They invest billions in any one year.’

There is also the possibility that reinsurers could have lost – or will lose – capital through investments linked to sub-prime mortgages, although Mr. Gayle doesn’t believe this is a big issue.

‘Based on our discussions [with reinsurers]… I do not get the impression that there is much direct exposure to the ‘toxic’ investments on the part of the major reinsurers,’ he said. ‘There could be indirect exposure via investments with Lehman Brothers, AIG, et al. This is, of course, compounded by the drop in stock values which has wiped out chunks of shareholders’ equity.’

Mr. Twohey believes the major reinsurers that have been around a long time probably did not have loan debt investments with the likes of Lehman Brothers, Morgan Stanley, Bear Stearns and other failed or troubled investment banks.

‘Many of the start-up reinsurers in Bermuda began life with funds from Morgan, Lehman, etc. – very natural as these as there were the money market powerhouses – and more recently from hedge funds after [2005’s Hurricane] Katrina,’ he said. ‘So, there is a lot of that kind of money in the newer entities.’

Greenlight Re

The Cayman Islands-based reinsurer Greenlight Reinsurance Ltd. had its own share of troubles last week. After forecasting a third-quarter loss of between $3.30 and $3.45 per share, Greenlight’s shares lost some 30 per cent in value.

The reason given by Greenlight for the projected loss was a negative investment return for the quarter of 15.9 per cent.

Greenlight President and Chief Underwriting Officer Bart Hedges said last week the problem had nothing to do with exposure to sub-prime mortgages.

‘We do not have any investments in mortgage-backed securities, credit default swaps, CDOs or CLOs,’ he said, referring to some of the many sub-prime investment derivatives.

‘Greenlight Re’s assets are invested primarily in publicly-traded equities, both long and short. Over the long run, this has worked out well. Our third-quarter investment result is due to the challenges faced in the equity markets’

Mr. Hedges said the sub-prime problem wasn’t an issue for the reinsurance industry by itself.

‘But combined with all the other [financial investment industry] events, it certainly contributes to a more challenging investment environment going forward and possibly more reinsurance underwriting opportunities.’

Rising insurance prices

Mr. Gayle, Mr. Twohey and Mr. Hedges all agree that the financial crisis has affected the capital on reinsurer’s balance sheets.

‘Indications are they will be obliged to seek to restore their shareholders equity by increasing their prices,’ Mr. Gayle said. ‘With less capital available to them, they have less capital to make available by way of providing reinsurance capacity and, as such, there may well be a shortage of capacity.’

Less reinsurance capacity will lead to increased prices because of simple supply and demand economics.

Mr. Hedges thinks that is what will happen.

‘We believe that companies will have less access to capital going forward and more focus on preserving current capital,’ he said.

‘Additionally, we believe the demand for reinsurance… will increase since other sources of capital like debt and equity will be more difficult to attract at reasonable prices. The result will likely be higher reinsurance prices in general and less capacity.’

Mr. Hedges said ultimately, the cost of reinsurance is passed on to consumers.

‘We think reinsurance costs will increase in general, even absent another event, so it is reasonable to expect that those costs will be passed on to insureds.’

Mr. Gayle said there was a very real possibility Cayman homeowners could face higher premiums.

‘A number of major reinsurers have actually stated that they anticipate increases and others have indicated that they will not make their capacity available if prices continue to decline,’ he said.

However, given the already higher property insurance rates in Cayman as a result of Hurricane Ivan in 2004, Mr. Gayle said Sagicor was still hoping Cayman would not be affected as much in terms of higher premiums as other countries where rates are lower.

Mr. Twohey believes some of what the reinsurers are saying now is ‘posturing’ in advance of renewal negotiations.

‘So I think, yes, there will be a push to increase the reinsurance rates,’ he said. ‘But I suspect that they will maintain, stabilise and not drop [the rates] and we should not see a dramatic increase in the prices, unless more major skeletons appear from the cupboards.’

Mr. Gayle said the insurance industry was still a good two months away from knowing for sure what the reinsurance rates would be.

‘To a significant degree, [the rates] will be influenced by what happens in the financial markets in the months to come,’ he said. ‘The situation could be better or worse than I have articulated thus far.’