Wednesday, 19 March 2008

Tipping Point

Commercial lines insurance pricing is set by the economics of supply and demand.

As evidenced by the chart on the right there is a serious imbalance. Using US policyholder surplus as supply and US GDP as demand for insurance, the ratio of supply:demand is represented by the red line currently at 3.7%.

Note that the median in recent decades is 3.2% meaning we are at high levels and that there is a fierce downward pressure on pricing.

When does it change? What's the tipping point? Could the new litigation beyond subprime bring about this change?

I heard an interesting take today from a senior reinsurance broker in London who says the tipping point has always been the first major reinsurance firm that refuses to write anything further and that this has a ripple effect, starting with the primary insurance underwriters that rely on this reinsurance.

This broker sees a period of time beginning in the next 6 months where capacity is scarce and serious profits can be made from escalating prices, despite the fact that as the crisis widens and deepens, Advisen's $3.6b estimate for D&O losses is likely to increase.

He sees Q2 2008 reports leading to painful discussions about reserves among underwriting firm managers and that this will lead to somebody being that first firm to close up the Financial Institution D&O shop.

In the meantime he's placing a ton of excess layers for those wanting to take advantage of capacity while it's still available.

As the turmoil in financial institutions continues to play out wickedly in front of our eyes, the insurance industry awaits the inevitable claims. The question is whether the inevitable contraction of capacity and increase in pricing will be isolated to financial institution D&O or even to D&O or whether the impact of these claims can have a material impact on overall insurance pricing.


John said...

Hello Mason - neat blog.

I wonder if the huge losses happen will we see another wave of money heading for Bermuda to write D&O and other lines that take hits from the Credit Crunch.

The Cycle used to be sharp upswings followed by gradual declines. Cariers made a lot of money during the gradual declines. Now the new money rushes in so quickly the decline in rates is over in a few years. That doesn't give the existing cariers enough time to rebuild their reserves.

John Walsh

Mason Power said...

When John Walsh of Reactions comments on your blog, you know you've arrived...

Hi John, thanks for the thoughts.

I remember many comments from Lloyd's underwriters when money last poured into Bermuda (versus London) after the hurricanes of '05, saying that it was needs-based and not opportunity-based meaning that Bermudian (re)insurers needed a capital infusion while Lloyd's was sound. Writers of D&O for FIs are spread globally, but it's the big players that have the biggest (gross) positions.

To your point about the cycle, my contact was practically salivating at the thought of having somebody shut down and seeing prices increase. Dave Bradford, co-Founder of Advisen and former Treaty Reinsurer for Swiss Re America, remembered fondly the flurry of activity when prices started to skyrocket. If enough powder has been kept dry, then we will see a lot of activity and a lot of market volatility.