THE ORIGINS OF THE CREDIT CRUNCH AND THE EMERGENCE OF A REINSURANCE CRUNCH

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THE ORIGINS OF THE CREDIT CRUNCH AND THE
EMERGENCE OF A REINSURANCE CRUNCH

• Reinsurance Trends and Lessons to be learned from
  the Global Financial Crisis
• The African Perspective.
• Rajni Varia

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We have witnessed the most difficult economic
environment of the last 30 years
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Global GDP growth, real p.a.
Oil Crisis
Early 90s recession
Dot-com bust
Credit crunch
Source IMF
3
While there are many interlinked causes, they all
centre around a very human failing GREED
,
USA household savings rate,
FTSE 100 Index
We believed the good times would never stop
Source IMF, Yahoo Finance
4
In the housing market, we believed prices would
rise forever, though experts warned us they were
too high
1996
UK House Prices, 000
House prices in the United Kingdom also
still seem overvalued by most conventional
measures IMF, September 2006
What caused this?
1995
2000
2005
2010
Source UK Land Registry
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A buyer who only considered the guaranteed
returns and ignored the risks
So we gave them
Wow! The Jones next door have made 100,000 on
their house! I want some of that

• 110 loans to help those who couldnt afford the
  down-payments
• Discounted mortgaged interest rates during the
  initial periods to help those who couldnt afford
  the repayments
• Self-certified incomes to help those who didnt
  have a regular income

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A broker who didnt care about the risks and just
wanted to get the commission
You guys are awesome! You are really willing to
work with guys like me
Well, we dont actually lend you the money a
bank will do that sow e dont care if you repay
the loan. We still get our commission.
Wow! Lets get started
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A bank that didnt really carry or understand the
risks they were selling

US mortgage backed CDO outstanding, tn
Id better get rid of these crappy mortgage
loans. They are starting to stink up my office.
Thankfully the really smart guys in New York will
buy them and perform their financial magic! Ill
call them right away
New mortgage file
96
97
98
03
02
01
2000
04
99
05
06
07
08
Source SIFMA
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Investment banks that were too far from the
customer to understand the risks
890
RSG Investment Bank of Wall Street Trust the
Really Smart Guys for all your investment needs
Sure, individually these are pretty crappy loans,
but if we pool them together, only some of them
will go bad certainly not all of them. And
since house prices always go up, we really have
nothing to worry about
US properties with foreclosure activity, 000
Q4
Q1
Q1
Q2
Q2
Q3
Q4
Q1
Q2
Q3
2007
2008
2009
Source Realtytrac
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So what happened?
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We all knew this. So what?
Lets consider the African Insurance/Reinsurance
market
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We have brokers who are only interested in the
commission
Ace Insurance Brokers We give you more for less
Let me get this right... You get me cheaper
premiums, extremely wide coverage, and even
reimburse cost of hiring an expert who will help
me maximise my claim. How can you afford this?
We dont actually cover the risks an insurer
does that and we still earn our commission
Wow! Lets get started then. You said i don't need
to complete a proposal form!
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We have underwriters looking for growth...
Big Insurance Company Your trusted and largest
insurer
So we give them
I have brought you a new client.. I used our
slip. ... Please don't ask too many
questions..no, theres no proposal form- i know
the risk..

• 10 discounts
• Riders
• Extensions
• Delete all exclusions
• Extended payment terms
• A real case had 127 special clauses!

If you do not want it ,I have many more insurers
waiting to take it
No problem, I will give you whatever you want.
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The insurance company does not retain the risk....
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Net retention for selected insurers, as a
percentage of gross retention
Big Insurance Company Your trusted and largest
insurer
Id better get rid of these crappy risks. They
are starting to stink up my office. Thankfully
the really smart reinsurers will take them from
me. Ill call them right away
Average 8.5 of gross retention
A
B
C
D
E
F
G
H
I
Poorly Rated Risks file
J
K
L
M
N
O
Source Realtytrac
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Reinsurer.. We need to support our clients and
provide local capacity...

Supersmart reinsurer of Africa Trust the really
smart guys
Combined ratio for selected reinsurers,
A
Sure the risks may look bad, but Im sure well
make enough investment returns to cover our
losses. Besides, weve grown our market share!
B
C
2006
2005
2004
2007
2008
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What are the trends?
û

• Worsening claims ratios
• Declining underwriting profits
• Inability to build up reserves to pay for future
  catastrophic claims.

û
û
We must learn our lesson
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So what might happen next?
Insurance company passes the claims on to the
reinsurer
Reinsurer cant pay and goes under
?
Will we break the cycle or perpetuate it?
Customer buys cheap insurance and maximise claims
Insurance company cant pay and goes under
Rates rise, breaking circle? OR Capital flows in
reducing rates again?
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Real Example of an All Risk Policy with free
special clauses
Claim details

• Sum insured 40m
• Premium 48,000
• 126 special clauses, increasing the scope of the
  policy, reducing protection for the insurer and
  encouraging moral hazard and bad behaviour on the
  part of the insured, for example
• Several clauses deleted (e.g., Electrical, Petrol
  and Mineral Oil Warranty)
• 85 average condition 15 capital additions ie
  30 in total
• Claim preparation costs
• Accidental error or omission/misdescription
  clause
• Stock declaration condition deleted
• Are adequate additional charges levied for these
  clauses?? I think not!

MD BI (Profits ICOW) Additional ICOW Claims
preparation cost Loss adjustor fees expenses
5.766m 3.056m 556k (12Xpremium) 37k
(0.8Xpremium) 501k (10Xpremium)
The insurers retained only 3.6 of the claim
!
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African Reinsurance Trends
ü

• International Reinsurers are either withdrawing
  completely or reducing their support
• Major African Reinsurers are realising the need
  to pay greater attention to the bottom line as
  opposed to the top line

ü
We are learning our lesson-hopefully
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Future survival - what the insurer needs to do

• Need to Return to the Basics-adhere to a code of
  ethics/underwriting
• -The Insured, Insurer and Reinsurer must all have
  an interest and benefit from loss
  prevention/minimisation
• Check quality of Risk/ client
• Proposal forms
• Risk surveys
• Understand and clearly define scope of cover
• Proper Rating and pricing of Risks
• Adequate excess
• Pay attention to the Bottom line

!
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Future survival - what the reinsurer needs to do

• Clearly specify the scope of cover provided
• Limit the automatic underwriting capacity
• Link commission to performance of the reinsurance
  contract

Proportional treaties

• Increased priorities
• Technical pricing of working and catastrophe
  covers

Non-proportional treaties
!

• MUCH MORE STRINGENT APPROACH TO ENSURE
  PROFITABILITY AND LONG TERM SURVIVAL.

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Rating agencies have a mixed outlook for 2009

• Changed outlook for Reinsurance Industry from
  stable to negative too much capacity without
  certainty of capital (Global Reinsurance
  Industry outlook 2009)
• Changed from Stable to Negative - Reinsurers
  ability to replenish capital after a major loss
  in the present economic climate a key concern
  (Global Reinsurance Review 2009)
• Maintaining a stable outlook in 2009 for the
  global reinsurance sector, which implies that the
  majority of 2009 reinsurer rating actions are
  likely to be affirmations, with only a modest
  number of anticipated rating or outlook changes
  (AM BEST-2009 Special Report Global Reinsurance
  Market Review. Reinsurers Stay Afloat in
  Sinking Economy)

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APPENDIX Real life example of an all risks policy
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Real Example of an All Risk Policy-special clauses

• Electrical clause deleted
• Petrol and Mineral Oil Warranty deleted
• 72 hours clause including all natural perils,
  riots and strikes
• 85 average condition
• Accidental error or omission/Misdescription
  clause
• Adjoining buildings
• All other contents US 20,000
• Appraisement Clause US 20,000
• Architects, quantity surveyors and consulting
  engineers clause
• Automatic reinstatement of loss clause

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• Breach of warranties/conditions clause
• Bush fire
• Cancellation (30 days) clause
• Claims preparation clause US 50,000
• Cost of demolition/clearance of debris clause
  US 50,000
• Cost of re-erection clause
• Capital additions clause 15
• Definition of building clause
• Definition of property clause
• Fire Brigade clause (municipal or private)

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• Mortgage clause
• Lien clause
• Municipal scrutiny fees clause
• Public utilities clause
• Reinstatement of value clause New for old
• Temporary removal (internal and external)
• Rent receivable, payable and rental value
• Contract price clause
• Computer system records clause
• Contract works US 20,000

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• Cross liability clause
• General interest clause
• Goods in trust and /or commission
• Import Duty clause
• Landlords fixtures and fittings
• Other insurances clause
• Parked vehicles
• Payment on account clause
• Property of employees and visitors US 5,000,
  in total
• Public Authorities clause

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• Riot, strike and civil commotion
• Spontaneous combustion
• Subrogation waiver clause
• Tenants clause either with the client as a tenant
  or the client as an owner
• Vehicle loads clause US 10,000
• Un-occupancy 30 days
• Arbitration clause
• Stock declaration condition deleted
• Malicious
• Accountants clause

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• Fire protection/security installation in
  operative clause
• Joint venture clause
• Protection of property clause
• Disposal of salvage clause
• Supplier or Manufacturers guarantee or warranty
• Property in course of construction
• Protection of Manufacturers guarantee
• Functional unit clause
• Co-insurers to follow the leader

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CLAUSES APPLICABLE TO SUB-LIMITS

• Machinery Breakdown
• Foundation /refractory brickwork
• Surrounding Properties
• Replacement Repairs
• Including Overtime, night work and expenses and
  airfreight
• Fundamental unit
• Expediting expenses 50
• Additional/replacement machinery
• Replacement capacity conditions

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• Business Interruption
• Alternative basis clause
• Additional increase in cost of working
• Finds and penalties
• Business increase clause
• Forward exchange losses
• Hire in plant
• Departmental clause
• Interests on loss sales
• Loss of interests

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Business Interruption (Cont)

• Suppliers extension
• Customer extension
• Prevention of access
• Public utilities
• Public telecommunication
• Accidental damage
• Payment on account

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• Money
• Definition of Money Clause
• Assault Clause/employees effects
• Deletion of keys clause
• Money held by employees/directors US 2,000
• Definition of transit in transit
• Cash box extension
• Premium adjustable annually on actual annual carry

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Money (Cont)

• Deletion of keys clause
• Fire, explosion, earthquake and all other special
  perils
• Infidelity of employees 14 days
• Cancellation Notice 30 days
• Including riot and strike
• Payment on account clause

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• Burglary
• Including hold up
• Including theft from the open US 10,000
• Including goods held in trust
• Cost of replacement of lost safe keys
• Payment on account clause

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• Electronic Equipment
• Damage by power surge/interruption damage
• External Data Media US 10,000
• Increased cost of working/hire costs
• Including fire, lightening, allied perils
• Including theft
• Including All Risks worldwide cover for movable
  equipment including but not limited to laptops
  and projectors
• Reinstatement of loss
• Replacement basis of cover

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• Electronic Equipment (Cont)
• Including expediting expenses
• Including temporary removal
• Replacement of basis of cover
• 72 hour clause of all natural perils and riot and
  strike
• 85 average condition
• Malicious damage
• Accidental error or omission
• Automatic reinstatement of loss clause
• Breach of warranties/conditions clause

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• Electronic Equipment (Cont)
• Cancellation (90 days) clause
• Claims preparation cost US 2,000
• Temporary removal (internal external)
• Import duty clause
• Payment on account 75 clause
• Subrogation waiver clause
• Mechanical and electrical breakdown including
  power interruption and surge
• Portable/mobile equipment but excluding motor
  vehicles licensed for road use

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