Exposures in the casualty insurance and reinsurance sector are inherently difficult to predict and model, meaning until a market transformation occurs the casualty space is likely the biggest threat to the re/insurance industry, according to Wills Re’s Andrew Newman.
Discussions of the pressures and ongoing challenges in the insurance and reinsurance sector have typically focused on property catastrophe business lines, where capacity is in excess and competition is high owing to benign catastrophe losses and the entry of third-party investors.
While it’s understandable for industry noise to focus on property catastrophe business lines when margins are thin as it’s generally the biggest driver of the industry’s profits, “in fact it’s casualty that kills companies,” according to Willis Re’s Co-President, Global Head of Casualty, Andrew Newman.
“It probably presents the biggest threat to the industry, earnings and capital volatility and insolvency.”
“There is a sense that cat drives profits and casualty drives losses, I think that the second bullet point is probably better. That casualty will come up behind you, you won’t know it’s there and will slit your throat,” said Newman, addressing an audience at the recent meeting of the reinsurance industry in Monte Carlo.
Some fairly strong words from Newman, but considering that nearly half of the industry’s financial impairments come from casualty, compared to roughly 7% being driven by cat losses, the need to address the risks and challenges casualty exposures present to the industry becomes apparent.
Over the last decade the casualty environment has been particularly benign and market participants have been “living off the results of the last five or six years,” serving to lull players into a false sense of security, says Newman.
While less dramatic than seen in the property space, prices in the casualty sector have started to decline, exacerbated by the benign loss period and the entry of alternative and traditional sources of reinsurance capital from investors looking for diversification and returns away from the testing property cat landscape.
Primarily, explains Newman, reinsurance exists to “hedge against volatility for earnings, volatility for capital and ultimately to immunise organisations from insolvency threat,” adding that Willis Re feels the focus on property is disproportionate relative to casualty.
Casualty exposures have the potential to be long-lasting, far-reaching and hugely damaging to companies and economies, with past exposures like asbestos still impacting the sector today, and significant emerging risks like cyber posing a real and immediate threat, the need for robust risk management and advanced modelling techniques is as essential as ever, says Newman.
Comparing it to a bookmaker on the racetrack, Newman highlights that like property cat models the bookmaker keeps note of their downside risk, so the liabilities they pay-out, instead of the odds that they take.
For property cat models this involves tracking the downside risk and then connecting that risk with the capital, but for casualty no such effective, or comprehensive model exists to achieve this, so instead downside casualty risks are based on premium rather than exposure, a flaw in the system according to Newman.
Newman notes that the “elements of the industry on the casualty side are driving at night without headlights on, and that’s normally a time for transformation.”
But change can be difficult, which is part of the reason the industry hasn’t attempted to properly transform the casualty arena in the same manner witnessed in property, coupled with the inherent difficulties surrounding modelling tools for liability exposures, says Newman.
Furthermore, the false sense of security the last ten years provided for the casualty landscape causes a lack of desire or willingness to change and adapt as players think they are in a new reality, “our view is there is no such thing as a new reality,” said Newman.
“On casualty there’s no effective model, the industry is very focused on how much it writes,” explains Newman, continuing to explain that in order to be sustainable casualty needs the same robust risk management and transparency as witnessed in property, or risk further challenges down the line.
But it’s not all doom and gloom for the casualty sector and according to Willis Re they aren’t the only ones considering change away from the current situation, as regulators, enlightened clients and boards of directors are showing an increased focus on gaining a better understanding of their downside casualty exposure risks.
Also, the development of advanced and comprehensive modelling tools utilising the wealth of analytics and data that’s out there in the world are starting to be implemented and made more available to the casualty space.
“If you could wind the clock back and look at what the arrival of models and confidence in calculating downside risk did for the property catastrophe business, we think that we’re on the dawn of a very similar landscape as far as casualty goes,” concludes Newman.