Issue 57
April 2016
In this Issue
  • If rates are sliding and more models are in use does that mean less risk?
  • Thoughts on the E&S market from the biggest US writer of the coverage
  • M&A activity: its effects on buyers, ratings and M&A insurance
  • An insurance coverage gap of gargantuan size in California
  • Roger's take on the Panama Papers and the obligation to pay taxes
  • Quick Bytes: Chinese insurers failing on data reporting; BoE warns on capital levels; MetLife Sifi victory short-lived; Mario Greco makes first statement and ECB is NOT planning on dropping Euros from the sky

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Dear Colleague, 
At 10 am EDT, Saturday April 30th the annual Berkshire Hathaway shareholder meeting will be streaming in live video on Yahoo Finance. We certainly are going to be watching as Warren Buffett's comments about reinsurance and insurance are generally front page news in the business sections of every newspaper the next day.
This month we've again noticed the increased attention that models are receiving from nearly every corner of the industry.  We also couldn't help notice more comments about sliding premium rates in certain LOB's and wondered about possible connections.
There were also comments this month about broker remuneration and we've examined that too.  
Lloyd's America CEO Hank Watkins had some interesting comments about the E&S market which prompted us to examine how models may or may not yet fit neatly into that market.
Finally, we noted a not insignificant "insurance gap" that's not in an emerging market but in California, the most populous state in the US.
Our regular Roger Crombie column is here too. Roger has seized upon the so-called Panama Papers recently released that identify millions of people with offshore bank accounts. You will see that he has no objection to such accounts but is appropriately upset with tax cheats.
As always if you have any questions or comments about CATEX Reports, or want more information about CATEX, please feel free to contact me.
Thank you very much.
Stephanie A. Fucetola
Senior Vice President/CATEX

Rate decreases, models, discipline and the dilemma of the broker

There is a "triple theme" we've seen this month in industry news articles.  First, modelers must be enjoying their days in the sunlight as once again it seems that everywhere you look more and more people are talking about modeling more and more risks.  What began as a means to estimate exposure to rare, devastating hurricanes is now becoming the bread you make the sandwich with --indispensable.

Next we were struck by continuing concerns about premium rate decreases. That's not new news but what was new to us, is that of all people, the ILS markets seem to be the ones slowing up in their underwriting because they can't get the premium they need.  You may remember the "hot money" moniker applied to them a few years ago.  Not so fast it seems. There have been documented instances of pull backs (translation: underwriting discipline) and the aggregate numbers lend support to this view.

Finally we're beginning to see the outlines of what may turn out to be more than just "normal" grumbling about broker remuneration.  It's undeniable that the "pie" has shrunk --premium rates are not what they were -- and intermediaries with revenue targets tied to commissions based on those shrinking premiums face a dismal prospect unless they work to remedy that by creating other revenue sources. It's those "other revenue sources" that are causing consternation in the market.

It's undeniable that there are more stories about modeling these days. The general thrust of the stories is that improvements in modeling technology mean that prospective users who rarely had direct access to models in the past now use them regularly.  This is music to the ears of the likes of OASIS and to the modelers themselves. You can imagine, though, some consternation within underwriting departments as long insured policies may now be accompanied by cold, hard, predicted loss numbers.  Arguments ensue, we are sure, when underwriters are asked to drastically increase a rate, or decline a risk, based on a newly run model, or on a coverage that may not have sustained a claim.

This discussion apparently occurs on a macro scale in very large insurers who make a decision to write business from a client at the less than required rate (as called for by the model results) in order to obtain business from the same client in a more profitable line of business. It all comes down to the numbers.  

With regards to model/actuarial price vs what the market will support, there is a useful ratio - TP/AP (Technical Price (modelled) / Actual Price (the price you can sell the cover for in the market).  Monitoring TP/AP ratios is sobering science for C level execs at the big (re)insurers.

If a company is big enough, and determines that the profit it could earn from obtaining the higher priced line is worth taking the technical loss on the lower priced line, it will underwrite certain LOB's at a loss. It works out pretty well as the big four reinsurers have been doing well.

A company needs to have scale, both geographically and in coverage types, to be able to succeed at this. For companies without scale they are required to choose between insuring the business at a near or certain loss, or simply passing on it and letting a rival insure it.  Often, this can be a wrenching decision. Client acquisition is a long, costly and arduous process and no carrier wants to lose a client. When this wrenching decision is precipitated by a model result alone you can be certain there are arguments.

Models aren't perfect --even the modelers deny that they are.  And when no major hurricane has made landfall in the US in nearly ten years (despite predictions) you can be sure that underwriters are mindful of that "fact" if they question why a long term piece of business is being passed on because of the model analysis.  On balance, though, that line of argument simply can't win when an insurer adds up the aggregate exposure to its entire book and factors in the prospective modeled loss. Insurers take risks but they don't take unnecessary risks.

This leads to an interesting trend. You may recall some of the traditional market reaction several years ago when the spigot of alternative capital coming into the market began to fully open.  It was thought that this new money was "dumb capital" or "hot money" and would underwrite any risk put in front of it simply to generate a premium.  As it turns out, and it's impossible to generalize this, there are cases when alternative capital has refrained from writing risks as the premium prices continue to plummet.

The clearest example is the reduction in the rate of alternative capital coming into the market.  Although the amount grew to $72 billion in 2015, S&P says that the rate of increase has slowed from prior years and that this slowdown "is a sign of a pricing tipping point having been reached in certain peril regions."  Translation: if the return isn't good enough, in this case the premium, the capital will go elsewhere.  

This macro evidence is one thing but when you look closer you see other signs too. Barbican's managed third party ILS capital Special Purpose Syndicate 6120 was hard hit by losses from the Tianjin port explosion and the Pemex oil rig explosion. The SPS in fact incurred a full year loss for 2015.  The SPS paid its obligated claims but has not renewed for 2016.  Translation: the ILS investors decided that after paying the 2015 claims their appetite for 2016 had waned.

What seems troubling though is that traditional reinsurance capacity actually did decline in 2015 and it wasn't just a slowing of the increase as with alternative capital.  Traditional reinsurance capital declined by 4% down to $493 million.  Some of this decrease was due to the stronger US dollar but no one is suggesting that the amount of traditional capital increased.  

Presumably this means that traditional carriers have determined that prices really are too low and they just simply will pass on insuring certain coverages if they can't get their price. Obviously this is what one hopes it means but there is much evidence to the contrary.  You have to wonder about underwriter discipline, and whether it's real or not, when you see a comment such as the one made by Evan Greenberg at Chubb. Greenberg said that "Many markets participants are simply gambling that if they don't have a normal level of expected CATS or large losses they will make money--a pretty dumb plan."

In the same vein, and even more critical, were comments from David Shipley of Managing Agency Partners (MAP) a Lloyd's syndicate who criticized rivals that are currently underwriting for volume saying that the strategy was "bordering on suicidal". The MAP active underwriter Richard Trubshaw said that in addition to prices being battered, terms and conditions in many classes were so far adrift of any reasonable view of a long term profit margin that "the day of reckoning cannot be too far away".

The dilemma facing markets is understandable. Premium prices have dropped so much that reinsurance demand has actually increased. When premiums were high some cedents decided to increase retentions and or centralize group reinsurance purchases based on enterprise-wide exposure. The net result was that the amount of reinsurance coverage they purchased declined and they retained the money that would have been paid in ceded premium.

Now, after a prolonged period of rate decreases, as well as the more generous terms and conditions alluded to by MAP, cedents are interested in reinsurance again. Not only is it more cost effective to offload the exposure elsewhere but recent claim events such as the Tianjin loss has left more than a few cedents wondering how they would have fared had they reinsured healthy portions of their exposure.

The demand seems to be creeping back but it's been prompted by prices so low that some in the reinsurance industry say would be "suicidal" to continue charging them. After a period of dwindling demand in certain lines, reinsurers are seeing renewed interest, but at prices they are reluctant to extend. You can see why at this stage any demand is hard to pass up but some markets are willing to do just that. It's ironic that certain ILS funds are amongst those who seem to be passing up business too.

In a down market everyone suffers but logically it would seem that brokers stand the most to lose. If less coverage is being sold, and the coverage that is being sold is at a lower price, then it stands to reason that broker commission-based revenue will decrease.  How can it not?  Only by three ways that we can think of.

First a broker could try to identify new clients and bring new buyers to the market. New clients who might be interested in either existing product lines or new product lines would be the clearest way to increase broker revenue. After all, how many stories can we read about "coverage gaps" and lack of insurance in "emerging markets" before someone actually gets on a plane to visit prospects who might not even have been aware that there are coverage opportunities available that could lessen their exposure and allow them to write more business.  

This is the essence of what a broker does. Several years ago Eric Andersen at Aon Benfield identified this process of  pure "organic growth" as precisely the path the broker intended to follow. 

Another path to increased revenue for brokers is a half-sibling of pure organic growth. By generating new products and services to make available to existing clients brokers can and do generate new revenue. These new services run the gamut from impressive new modeling capabilities to London market broker facilities.

Services pertaining to better understanding risks would seem to be work that no one can object to. Who is going to deny that should a broker develop a more accurate model, or a better analysis of an insurer's aggregate exposure, that these are positive developments? Besides, the client has the option of deciding whether it will buy the service or product and can decline if it wishes.

Where the broker revenue increase effort begins to encounter market pushback is when increased commissions and fees are added to services that the market has trouble justifying paying. For example Willis has recently tried to add an iincreased commission on Slip Market Brokerage on a range of London specialty placements. The reported rationale was to help defray the additional cost of transacting business in Lloyd's.

Most cedents are well aware of the commission differential already in place between business placed into Lloyd's and London compared to the US, Bermuda or Europe. Apparently though, for some, the current differential (estimated to be at least 5 percentage points) is not enough.  

A more well known example of when the market reacts to broker efforts to increase remuneration is of course the argument over the follow form facilities set up by brokers at Lloyd's. Markets that decide to join the panel are typically required to pay an upfront fee to the broker to be able to participate in the facility and the broker receives an increased commission fee as the facility manager.

On one hand it's indisputable that sophisticated markets have made decisions in their best interests to join broker follow-form facilities and pay the required fees. Presumably, they are capable of acting in their own best interests. To be fair most of the negative publicity surrounding the follow-forms come from markets which decided not to participate or were not invited to participate. Such markets may feel that their underwriting independence has been thwarted. The facility is called a "follow-form" facility for a reason.

Follow-form revenue and slip revenue may indeed be new revenue sources and can probably be categorized as organically new revenue. But these streams are distinct from pure organic revenue growth that comes from identifying new coverage needs and bringing new clients to the market.  

We mentioned that there are three ways a broker could increase revenue in a down market but thus far have only identified two. This next one is a bit like Lord Voldemort's name that cannot be spoken and we hesitate to bring it up.  

In any other market when demand slackens prices are usually adjusted downwards. The goal usually is to make your product more attractive to buyers. In the case of insurance, and reinsurance especially, the premium prices have declined so much brokers can quite rightly say that they have already adjusted their price. Their commission rate has remained the same but the lower premium means that they're receiving less than they normally would have and are still providing the same services.

This requires a bit of parsing but we think it's the way the brokers see it. The brokers of course are not capacity providers. Just because it is a slack market, and the cost of the product they are selling has decreased, they still have to perform the same services --placement, contracts, claims, etc. -- that they would if the cost of the product had stayed the same or increased.  

An analogy could compare this process to owning a global oil pipeline network. The owner needs to keep it operational and deliver oil to distant locations regardless of the price of the oil running through the pipeline. Those pipes still have to function the exact same way whether or not the price is $20 per barrel or $80 per barrel.

If we follow this pipeline analogy a bit more, aside from imposing new fees, such as pipeline inspection fees, pipe maintenance fees, etc., the only way a pipeline network owner can increase revenue is by pushing more oil through the pipes. He doesn't control the price of the oil. One way to do that might be to lower the price for the service in the hopes that more oil producers will flock to his pipeline network to save distribution costs.

There. We said it and the sky hasn't fallen in (yet). We can't help but observe this is one aspect of any market, which all of us who make a product comparison in a grocery aisle, encounters every day that is never mentioned in any article. 

We detect rumbles of thunder in the distance. Lord Voldemort? Let's hurry on to some other developments.

From the "horse's mouth": E&S no longer a secret

Hank Watkins is the President of Lloyd's North America.  In remarks made at California State University last month he made some interesting observations.  He was speaking at a "Career Day" for university graduates about insurance.

Watkins described the Excess & Surplus (E&S) lines business as the "best kept secret" in the insurance industry.  E&S business is coverage that can't be obtained from an insurer admitted in a particular jurisdiction but is available from a non-admitted carrier. The buyer usually needs to certify that he cannot obtain the coverage from an admitted carrier.  In the US, states have long institutionalized protections for in-state insurers, but if the admitted carriers don't offer a coverage the state has an interest in having the risk insured if only for economic purposes.

Everyone knows what E&S coverage is. We've all heard the famous examples of coverages obtained in the E&S market not available in the admitted markets that have provided insurance for risks such as Betty Grable's legs and Bruce Springsteen's voice. We may have encountered the E&S market ourselves if we are members of a homeowners association that requires hard to obtain liability insurance or if we have a high value home in a flood zone.

It's been tough lately to make money in the E&S market (we're told) as premiums have dropped over the past two years. But risks continue to be written and more participants have come into the market. Whether the continued activity is due to the attraction of the E&S market or the lack of attraction in other markets we can't say. 

Maybe it had been our own lack of curiosity but it was a revelation when Watkins explained that the "E&S business insures risks that other insurers won't; and then when the E&S sector proves those risks are insurable, or a good business to be in, the rest of the industry moves in to offer products for those risks".

He cited autonomous vehicles, drones and ridesharing as emerging risks that the E&S sector took on first.  Other examples, such as satellite coverage, are more well known and well institutionalized by now. Lloyd's is the largest surplus lines insurer in the US. No wonder Watkins was waxing eloquently about E&S business as it represents over 60% of Lloyd's US premium. 

The observation that attracted our attention was when Watkins described E&S as a sector that will insure most risks, including modern and still little understood risks like cyber. Watkins noted that he is unsure whether the current modeling is adequate to accurately assess cyber risks, because the economic harm of such attacks may be simply unforeseeable. He said "I'm not convinced we're there yet. We have no idea what the downside is of cyber-attacks." The E&S markets though are writing the risks.

This comment reminded us of comments made by Brian Duperreault of Hamilton Insurance when he said that Hamilton is simply not going to write cyber coverage until more is known of the "downside". Hamilton isn't alone in this view (try to buy a cyber coverage) but obviously someone is writing the business.  How are they pricing it? How are they estimating potential losses?  

We can understand the lack of information, modeled or not, connected with cyber coverage. It is a new type of coverage.  But deeper in the article about Watkins' talk at Cal State were comments from Anthony Manzitto, COO of Topa Insurance Group. Topa is a California specialty lines carrier that writes on a non-admitted basis in a dozen US states in addition to the 20 states it is admitted to write.  They are obviously familiar with the E&S market.

Manzitto, mentioned the Aliso Canyon gas leak in the Porter Ranch community of Los Angeles.  That "event", which was essentially an uncontrollable leak of methane gas from the second-largest gas storage facility of its kind in the United States, has turned out to be the largest accidental discharge of greenhouse gases in US history.  Manzitto said the effects of the leak, which sickened and displaced thousands of people, is "a gigantic loss where there is going to be a number of E&S carriers involved."

Let's look at the Aliso Canyon leak differently from a cyber risk. The Aliso facility was the second largest methane storage facility in the US and and owned by Southern California Gas Company. Presumably, the dimensions, capacity and content of the facility were known down to the cubic centimeter. The underground facility has been used for gas storage since 1973. The location of the facility was certainly known as was the size and extent of the surrounding residential community. It seems that there was no information or data about this risk that couldn't have been known.

However when SoCal Gas went to look for liability coverage for their Aliso facility they ended up in the E&S market.  Is this a surprise? Probably not. After all it would seem that even a rudimentary model could compute the risk of potential harm from an accidental discharge involving a cache of methane big enough to fill the country's second largest storage facility located in close proximity to residential communities. Maybe the model didn't count on a methane leak that lasted for 111 days, but whatever size and duration leak the declining underwriters did foresee, it was enough to force SoCal Gas to the E&S market because they couldn't get all the coverage they needed from admitted carriers.

Back to our refrain. Someone insured the risk. Despite modeling results, that made the risk unpalatable to the admitted market, the risk was insured in the E&S market. We have no knowledge of the SoCal Gas insurance program. We don't know whether they retain a self-insured layer or not. We are only noting Manzitto's observation about the "gigantic loss" and that "a number of E&S carriers" will be involved. 

The E&S market has been walloped by the overall slump in insurance premiums but rates are generally higher than in the admitted market. Most admitted insurance rates are regulated but in the E&S arena the rules of the market govern. It goes back to what Hank Watkins observed. Part of the E&S carrier experience is determining whether the coverage can be profitable. If it is, then the rest of the industry moves in to offer that coverage. 

There is evidence that admitted carriers are moving into the E&S space. There is simply too much risk capital available to ignore a sector of the market that generates a higher level of premium.  Even Berkshire Hathaway Specialty Insurance has an appetite for it. When you remember the often stated goal of moving down the food chain to get closer to the risk, what could be a better relationship than providing a unique coverage to a buyer that has already tried but failed to buy the cover from an admitted carrier? 

There is one problem that we can think of and that is "E&S risks are considered high hazard, and often little historical loss data is available."  If we combine the lack of historical loss data, and the paucity of available models mentioned by Watkins, we can see why carriers, such as Hamilton, have decided to pass on certain types of coverages.  

Other carriers, exposed to the same gaps in risk quantification, do decide to provide the coverage but at a price they set and within limitations they insist upon. The E&S market offers this flexibility as E&S carriers "have freedom of rate and form, allowing them to write more exclusions, waivers, and riders than a standard policy in order to meet their clients' unique needs."

Lloyd's Watkins had another observation too, about E&S acting as a "surge tank" for the industry. He sees it as a role it plays when insurers pull out of risky markets and the E&S sector moves in. What's clear is that, just as carriers are matching coverage premiums and profits with appropriately priced capital (written on their own book, a sidecar or ILS vehicle, etc), they are also matching their admitted and non-admitted companies with "high hazard" risks if they desire to insure them albeit with a more limited contract and with a premium that's not regulated.

We wonder, given the increasing import of modeling, and the reasoning of the likes of Hamilton for not entering a market like cyber (lack of quantifiable metrics), how it is that E&S carriers could end up on a fairly quantifiable risk like Aliso Canyon. Presumably the rates they charged were formulated with all the model information available and the the nature of the E&S market allowed them to obtain a high enough premium for the "gigantic loss" they may now face. We wonder how much effect competitive pressures might have had on those rates.

We did note this from a 2015 A.M. Best report: "Underwriting discipline and sophisticated pricing models allow E&S carriers to design and develop products providing appropriate coverage. The ability to advance these differentiating products continues to benefit this niche as the next generation of new exposures develops."

Watkins would seem to be right on target. The E&S route may allow carriers to slip the regulatory leash in terms of pricing. By using the "sophisticated pricing models", noted by A.M Best, whatever those models may be, E&S carriers can get the premium prices they need. This is one area where underwriting discipline is key. As PwC observes about the E&S market, "There is potential for significant exposure to shock loss (such as catastrophic events or triggers), large risk concentrations, unique operations, unfavorable management, and emerging risks." 

You can't afford too many mistakes if the risks are that high. You especially can't afford too many mistakes when competition is fierce and when others will write business that you may pass up. Sometimes avoiding a mistake might just mean doing nothing. 

Effects of (re)insurer M&A activity

According to David Sloan, the CEO of Aon Benfield Canada, there has been "very little impact" on brokers and cedents from the recent M&A activity in the reinsurance industry. Sloan, a broker, was looking at the levels of available reinsurance that could be bought by cedents so his "impact" examination was limited to looking at the level of capital still available to underwrite.  

When asked what impact the industry consolidation in global reinsurance is having on cedents and brokers Sloan said "In the last two to three years there actually has been quite a lot of activity, varying in type and scale, but I think the real impact has been minimal." Sloan pointed to the levels of capital from both traditional and alternative capital sources as being more or less at record highs as the reason that "some level of consolidation has very little impact on that."

In regards to that capital he said "The diversity in that capital is also fairly significant. The market remains fairly fragmented, there are lots of new different forms of capital so it still provides an awful lot of choice for buyers, so it really hasn't changed that dynamic."

When we first saw Sloan's comments they didn't exactly seem like a news bulletin.  After all, we already did think that one of the reasons reinsurers merge was more effectively to deploy the aggregate capital of the newly combined entity. Then Sloan said something that stopped us. 

When talking about the deal that didn't get done --the proposed acquisition of PartnerRe by Axis -- he noted that the combined company would have been a bigger company, with better balance and a better spread of business. He went on to say of the proposed deal, which was never consummated, "It wasn't necessarily to remove capital from the business."

Of course this would be Sloan's concern. As overcapitalized as the reinsurance market already may be, any merger of reinsurers risks a newly combined entity shutting down one arm of the operation that would directly compete with a sister arm of the new company, thereby subtracting available capital from the market.  By withdrawing that redundant capital the thinking compelling the merger push would be to deploy it more effectively elsewhere. And as Sloan undoubtedly knows, reinsurers aren't exactly eager to start writing new lines of business.

In all the discussion about M&A activity over the past 18 months we had only looked at the prospective effects of that activity on the reinsurers themselves and quite overlooked the effect on the buyers of reinsurance coverage. Sloan's comments were a necessary reminder that even if capital subtraction has occurred as a result of a merger there seems to be an ongoing inflow of replacement capital available. The "replacement capital" can make up for capital returned to reinsurer shareholders via special dividends or stock buybacks connected to a merger.  We often read reports of shareholder pressure on reinsurers to return unused capital to shareholders but from the broker and cedent perspective they want that capital back in the marketplace.

We have a mental image of columns of marching reinsurers headed into the M&A stadium carrying banners proclaiming "Only the biggest will survive" or "We need to be big to provide one-stop shopping to clients". Both points may be valid enough for executives and boards to join in the M&A frenzy but we wondered, after the dust settles on a deal, how does it turn out from the perspective of a ratings agency?

Standard and Poors says that since the year 2000 more than two-thirds of (re)insurance industry M&A deals failed to improve the financial strength to permit an upgrade to the buyer. According to Artemis the S&P data says that for the buyers in the 50 largest M&A transactions involving rated insurers since 2000 some 64% saw their ratings affirmed as stable and 22% sustained negative outlooks.  Only 14% saw positive ratings action following the completed transaction.

S&P released this data to illustrate how difficult it is to achieve the synergies which are usually promised in the lead-up to the deal and which prompt the acquisition in the first place. S&P said "We rarely factor these synergies into our ratings until we can see that they have been realized. In fact, we have identified synergies as a strength to an announced deal 5% of the time since 2000."

That number is not a misprint. We checked it. So per S&P, from a ratings perspective, the promised "synergies" that prompted the deal at the start, have only been identified as a strength just 5% of the time. S&P continued, saying "History shows that these synergies are often difficult to achieve, and quite often the goalposts move or are forgotten in the years after the deals are done."

Despite this depressing news S&P says they "believe the deal-flow will continue, albeit at a slower pace, in 2016."  We couldn't help but remember the S&P story when we read this story in Insurance Insider with the headline "Inexperienced M&A insurance entrants threaten market dynamic". 

The growth of M&A activity, not only in insurance but globally, has had an effect on the sale of a little known M&A insurance product. According to Marsh, last year was a record year for M&A insurance. Buyers and sellers in M&A transactions bought $11.2 billion of cover or 45% more than 2014. The policies give the insured protection after the completion of a deal in the event anything unusual pops up. The most common forms of M&A coverages are warranty & indemnity insurance, litigation buyout coverage and tax liability insurance

This type of insurance is something that could fall under Hank Watkins' E&S description. David Whear, a partner at the law firm of Norton Rose Fulbright said in an FT article "20 years ago the M&A insurance product was pretty rudimentary but over time, the buy side product has been developed into something that can be used as part of a tactical approach to M&A."  

With the increased interest in M&A insurance the carriers which traditionally have offered this coverage, such as AIG, Allied World, Ambridge and Ironshore, have found a lot of company of late.  But as the Insurance Insider article notes "New entrants looking to jump on the M&A insurance "gravy train" are at risk of serious losses should they lack the necessary underwriting expertise."

It's an interesting article and notes that established players are questioning the supposed race to the bottom in pricing from new entrant underwriters seeking to establish footholds in the market while failing "to grasp the low frequency, high severity nature of the risk."

One thing that everyone seems to agree on is that one of the things that makes M&A insurance credible is that there have been a number of large claims paid. Data released by AIG, one of the largest M&A insurers, showed that in 2015 about 14% of policies resulted in a claim.  According to David Whear "It has been important for the market to show that it will pay". 

Whear's rationale for the importance of a claim payment differs from the rationale expressed by a current market source when complaining about the new M&A insurers. This source said "If some of the new markets did get burnt, it would at least demonstrate you can't just come in and bring prices down."

To sum up the M&A picture one could conclude that; from a cedent perspective the reinsurer M&A activity has had little to no effect; M&A activity generally doesn't produce a positive ratings action; the positive synergies advertised as the raison d'etre for the merger only occur in 5% of the cases; and the sale of insurance to protect buyers from the risk of nasty surprises once the deal has completed has skyrocketed. 

Insurance coverage gap in a heavily saturated market

We have all read countless articles about the so called "insurance coverage gap" in the emerging markets. Just this month we saw articles relating to; the need for regional insurers to better manage their exposure to the risk of flooding in the United Arab Emirates; 1.4 billion people living in South Asia acutely exposed to at least one type of hazard and who live in areas with insufficient resources to cope with such an extreme event; comments from Lloyd's Inga Beale that the threat of climate change affects some parts of the world that "don't really know about insurance"; a Swiss Re study showing that less than half of all global economic losses were covered by insurance in 2015; and that water levels in China may swell up to 80% in the Yangtze River valley this spring possibly resulting in flooding that will affect over 200 million people.

We've no doubt overlooked several other such stories but we sat up when we read a long article in MarketWatch about California earthquake coverage. The comments that attracted our attention were from David Schwartz a USGS geologist who said "California is completely uninsured. I can't tell you which fault will be the first to go, but we know that these faults have to move. You can run but you can't hide".

The number of California homes with earthquake insurance is only 10%.  The story of the California Earthquake Authority (CEA), and the deaf ears of homeowners turned to state officials imploring them to buy earthquake insurance, could probably fill several books so we won't even try to address it here.  

One statistic quoted in the article bears repeating though. According to the CEA the insurance "gap" in the San Francisco Bay Area is $602 billion, assuming $692 billion in reconstruction costs, and only $90 billion in earthquake insurance in force

Per Swiss Re the gap between global insured losses from natural catastrophes and man-made disasters which actually did occur in 2015 was $58 billion.  

The insurance gap it seems is not only confined to emerging markets.
The release of the Panama Papers and what they don't mean
But Roger explains what they could mean

Roger Crombie

You will be familiar with the concept, if not the contents, of the 'Panama Papers'. The 11.5 million documents, more than 2.5 terabytes of data, was stolen from Panamanian law firm Mossack Fonseca. It reveals details of those who have used the firm to obscure details of their wealth or transactions, mostly offshore.

Mossack Fonseca's services include incorporating companies in offshore jurisdictions, the administration of offshore companies, and wealth management. The Panamanian firm is the world's fourth biggest provider of offshore services, and has acted for more than 300,000 companies.

Full disclosure requires me to inform you that I have had offshore bank accounts for more than 40 years. I lived offshore for 35 of those years, and kept one account open after my return to the UK as a taxpayer, to enable my offshore clients to pay me for writing services rendered. I pay every penny of tax that UK law requires, and sometimes (unavoidably) a few more pennies than that, due to the poorly constructed nature of the UK's tax regulations.

But enough about me.

The Papers reveal that thousands of politicians, labour leaders and other public and private figures have taken advantage of their countries' tax laws, or simply cheated on their taxes. Within a week of the Papers being made public, Iceland's Prime Minister Sigmundur Dav Gunnlaugsson had resigned. British Prime Minister David Cameron, having done nothing illegal, trapped himself deep in the mire of implausible deniability.

Not in such hot water was Russian leader Vladimir Putin. He is said to own 20 homes, 58 aircraft, and a large fleet of cars, planes, boats, and yachts, as well as having a couple of billion invested offshore. That's pretty good going for a man whose annual salary is reportedly the equivalent of $145,000 (less tax, perhaps).

Officially, Putin owns just two apartments, two GAZ Volga cars, a garage, and a caravan. It requires no great stretch of the imagination to conclude that the unofficial estimates that rank Putin as the richest man in Europe are likelier to be true than the official record. After all, he has shown rank disregard for other laws that don't suit him.

Little will happen to Putin or many of the others whose names were revealed as a result of the Papers being leaked. Many will have broken no laws whatsoever, and many more will not have evaded the truth as Cameron did, coming up with five different stories in a week in an attempt to head off criticism of his father's wise strategy of legally investing family funds offshore.

Amid the hand-wringing and accusations flying around, a few key facts have been overlooked.

First, offshore does not mean illegal. The laws of most countries require citizens to pay as little tax as is possible, provided they meet all the requirements of what can be several thousand pages of tax law. Obscenely high tax rates make it sensible to reduce one's tax to the legal minimum. Only a fool would overpay his taxes - would you disagree with that statement?

But only a cheat would hide assets or earnings from the taxman. This will sound awfully quaint, but we all have a responsibility to pay what we owe. It's known as the social contract. You use the roads, the street lighting, the libraries, the schools and the other services provided by your government, and you pay for them what that government demands. Even if you don't use them, you pay your share.

To not pay what you owe is to threaten the society you live in. To believe that others should pay up, but you are exempt, is egotistical and arrogant, and should lead to your being identified and punished as a criminal.

What needs fixing here is not the morality of those smart and well-connected enough to use the Panama connection, but the tapestry of laws around the world that requires and allows them to do so. If all the countries assembled - say at the United Nations - and declared a unified global tax system ... well, that's not going to happen.

No other solution presents itself, so the status will remain quo. And that's that.

It now only remains for me to tell you that the British Virgin Islands, one of the most widely used tax havens, got its start in that capacity following the decision in the late 1980s by a Hong Kong mogul to site his holding companies in the BVI. His name, and you can't make this up, was Ka-shing.

Footnote: The US Government has compared the profits made by US-controlled companies in foreign countries with those countries' GDP. The largest results were:

Cayman Islands: 2,065%
British Virgin Islands: 1,803%
Bermuda: 1,614%
Luxembourg: 127%
Bahamas: 71%
Ireland: 42%
Netherlands: 17%

Roger Crombie is an American Society of Business Publication Editors national award winner. An English chartered accountant who lives in Eastbourne, on England's South Coast, he writes and broadcasts news and opinion in the US, UK, Bermuda and the Caribbean, in print and online. His main beat is insurance and financial services, with 30-year sidelines in music and humour. All views expressed in Roger's columns are exclusively his own. Contact Roger at

Copyright CATEX Reports
April 25, 2016
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