In this article, we consider the current issues facing the hull market. In addition to three members of our marine team – Sean Woollerson, Nick Lockyer and Andreas Liasis – we invited Peter Townsend from Swiss Re and Bob Clarkson from Brit Insurance to debate the issues.
What is the current climate in the marine insurance market?
Sean: The market is really soft and seems to be softening. Where is it going to end?
Bob: In the recent past, high freight rates and therefore high asset values, increased volume of ship construction work and war risks premiums have all benefitted the market, so while the market was softening, the actual premium earned was maintaining a level. But now we have an influx of capacity and asset values have come down significantly, ship construction is down, and war is pretty benign at the moment, the market is feeling the effect.
Peter: I think the biggest issue we’ve got is that the Costa Concordia – a USD 2 billion hull and liability loss – did not turn the market. If that doesn’t turn the market, what sort of loss does the market need in order to change?
Bob: I feel it did turn the market fractionally, arguably for 12 months. It just did not move it very far in terms of a positive rate improvement.
Peter: I think Solvency II means we are looking at a perpetual soft market. That is because the basis on which capital is allocated under Solvency II means there is a diversification credit for capital providers, so companies can use capital twice for non-correlating business. That means capital providers are prepared to take a lower return on capital. If the market starts to harden we’ll get an influx of even more capital, which would tend to depress rates.
Nick: But alongside that, we have had nearly two years without any dramatic losses. So while premiums have been coming down, claims certainly haven’t been going up. What happens when this benign loss scenario finishes?
Peter: There are two elements to a hull price – one is the premium to cover working/attritional losses and the other is that to cover the catastrophic loss. With the lack of catastrophe losses in the last two years, underwriters are using that premium to pay working losses. If this situation is the new norm, we can survive. But if there is a return to a higher incidence of catastrophe losses then we are in trouble.
Andreas: Another big issue is cyber risks – that’s a really hot topic at the moment. Anyone can actually hack into a vessel and change the chart and make the vessel think it is somewhere that it is not.
Peter: The University of Texas has already done it – a GPS spoofing test where they took control of a mega yacht under test conditions.
Will there be more consolidation in the insurer and broker sectors?
Peter: If we look at the mere fact that two of the largest Lloyd’s marine syndicates have combined XL and Catlin, rather than the two smallest. I think that must indicate the way that some companies are thinking. And if insurers can reduce fixed costs through consolidation, there is likely to be more.
Nick: What about on the broking side? We have seen Willis and Miller in mergers haven’t we?
Bob: There’s typically an appetite to grow every business. Obviously for those companies that are listed, it is almost a prerequisite that they don’t just stand still. So how do brokers a) grow and b) maintain profitability? If they haven’t made the necessary return on equity, they are going to have to make a move.
Peter: One of the capital providers’ requirements is they want to see bottom line growth, but they also want to see top line growth – and they are almost mutually incompatible. If you can’t get profits up you need to get costs down, which is one reason why we may see more consolidation rather than less.
What is the appetite of capital providers towards the marine market and what are their expectations?
Andreas: There seems to be a huge amount of capital around looking for a home, and a lot of it is coming into insurance.
Bob: Part of the problem is the capacity has nowhere else to go.
Peter: The business model has been replicated many times. You have a hurricane in the States, the insurance market gets hit and property CAT rates rise heavily. You then get a new entity set up, which is basically a roulette underwriter because they are writing only property cat for high returns, unencumbered by previous losses. That quickly results in overcapacity in the reinsurance market, rates fall, and those new entities need to write more to expand and diversify, but the only way they can do that is by putting more capital in. So companies tend to write property CAT business to start with and then diversify – often by setting up a Lloyd’s vehicle to write everything other than CAT-exposed business. We’ve seen it many times, for example with Validus, Ariel, Montpellier re, ACE and XL.
Sean: In terms of expectations, do capital providers generally demand a percentage return (for example 15%) on capital employed from their underwriting units
Bob: Yes – that’s very common. Everybody has a business plan and to get that signed off by your capital providers requires a prescribed year-on year return on equity which can be achieved across the cycle. However, it’s a challenge to all businesses to make sure that the numbers are achievable. Plus Lloyd’s has challenged a number of syndicates and agencies on their figures.
Sean: So you have to convince your capital providers – and then you have to convince Lloyd’s that your plan is achievable.
Are there any trends in claims activity?
Peter: Our book, on an exposure basis, is far more volatile than it ever has been. We are definitely seeing fewer claims, but while frequency is down, severity is up and that’s a consequence of the increasing use of bigger ships. They get goods to their destinations pretty efficiently – but when one goes wrong, you know all about it.
Bob: We have certainly seen fewer claims in the last three years. I think that is because the industry has improved – the ships are better and the equipment is better, as is cargo management.
Peter: If you look at the Lloyd’s loss book from 20 or 30 years ago, there would virtually be an incident every single day, now there are likely to be large intervals between such losses – which is the reason why those ships were paying that much more premium.
Nick: Improved technology and aids to navigation has certainly reduced the number of navigational errors.
Have there been any developments in the reinsurance market that have impacted on direct underwriters?
Sean: [To Peter] We have discussed in the past that you don’t buy any reinsurance – it’s all retained internally, which I think is good for a company of your size
Peter: I believe most hull books are net retained for single risk exposures. So the only time they would ever collect a reinsurance recovery is if there were an incident involving a combination of interests or a combination of hulls.
Peter: The reinsurance market is now under greater pressure than the direct market. There is an abundance of capital out there trying to find a home, so capital comes in, direct underwriters buy reinsurance, and therefore the cost of their reinsurance comes down. They can either retain the difference or move it down the food chain, which tends to be what happens, and give reductions themselves, their cost of capital is reduced because their reinsurance costs are reduced. It’s the old adage of the reinsurance tail wagging the insurance dog.
Bob: Although I think that the tail is at least getting shorter on the dog, to the extent that retentions are getting higher and therefore less likely to have an impact.
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For further information, please contact Sean Woollerson, Partner, Marine on +44 (0)20 7558 3866