Property Market Eyes New Entrants from China, Berkshire

Although new competitors are entering the U.S. property insurance market and alternative capacity is moving into the reinsurance space, neither trend has yet to move the needle on primary insurance pricing, executives said at the Advisen Property Insights Conference.

Speaking on the potential for alternative reinsurance capital to alter short-term market dynamics, “reinsurance overall is not a major factor in the cost of doing business for us,” said Paul McNamee, president of North America Property & Specialty Lines Insurance for ACE North America. “Certainly loss activity is by far and away the big driver of expenses.”

McNamee said he sees “a lot more” long-term pricing implications from the interest rate environment, and more particularly from inflation. “The reserves in the industry are so vast that if you put a 1 percent or 2 percent increase in inflation on those loss reserves, it will dwarf a $100 billion market loss,” he said.

Moving from the long-term dynamics of macroeconomic monetary policy to the short-term potential drivers of market change, McNamee pointed to the entrance of new markets into the insurance space. For example, Berkshire Hathaway Specialty Insurance started operations a couple of months ago with excess and surplus lines business, including property, as a core focus.

“And we’re seeing the increasing emergence of Chinese companies writing U.S. business,” McNamee continued. “That is the short-term effect in the market. It’s going to be the voraciousness of that activity, coupled with the tenacity of existing carriers to keep their business,” that will shape property insurance market conditions for the balance of 2013, he said.

Vic Krauze, chairman of Willis North America, said he also is intrigued by the new entrants.

“You’re seeing some of the capacity that comes in being less opportunistic. I always thought of Berkshire as an opportunistic player – [moving] in and out, depending on what’s going on. But what [Berkshire Hathaway is] doing is not a short-term play,” Krauze said. “We will see what’s developing with some of these Chinese markets moving in. I find that very interesting,” he added.

Otherwise, Krauze said, he’s “almost giving up on trying to predict what [property insurance] rates will do.” He noted that a combination of wishful thinking and messages about significant capacity moving in had brokers making more optimistic price forecasts in January than in the spring, and that price stability would be the best outcome for everyone.

Enter China

In an onsite interview with Carrier Management at the Advisen conference, Duncan Ellis, managing director and U.S. property practice leader for Marsh, confirmed that Chinese insurers are indeed writing U.S. property risks. While they’re winning some business on price, he also said they’re not making any market-changing dramatic cuts.

“We’re seeing a fair amount of capacity coming into the marketplace from these Chinese markets,” Ellis said. “We’re accessing it in China mostly for our very large, global clients,” such as well-known names in retail and manufacturing.

Ellis explained that for many years, his customers used these Chinese insurance markets inside China for the local admitted business. “If you needed to get a policy in China, you would go to the PICC (People’s Insurance Co. of China), the Ping An or the CPIC (China Pacific Insurance (Group) Co. Ltd.)”

Those companies are now seeking to write not just China exposures but global exposures on property insurance accounts, including U.S. exposures, he said.

Why is the capacity offered by Chinese insurers attractive to buyers?

“I don’t think it’s more attractive. I just think it is providing competitive tension on their program,” Ellis said. “Pricing is good,” he added, when asked if competitive tension is driving it lower.

The Chinese insurers “haven’t, at least in the United States, sustained some of the losses which have got other carriers thinking about some rate issues or adequacy that they need. But it’s not cheap capacity by any means,” Ellis said, describing it instead as “at-market capacity.”

Ellis suggested that for many large American corporations doing business in China, the purchase of insurance from Chinese insurers is a way of “showing good corporate responsibility or alignment with that country.”

He clarified that customers would not place an entire property program in China but “just a sliver of it.” These are large, global programs, he said, noting that there are often 20 or 30 carriers involved. The Chinese carriers would “be but one of those carriers” and might provide a 5 percent or 10 percent quota share all the way up an entire $1 billion program, for example.

As a broker, his reasons for recommending this to customers have to do with alignment and insurance market competition.

“You have a lot of U.S. companies that are looking toward Asia for growth,” he said, giving the example of a manufacturer opening a plant in China and selling its wares into the local marketplace. “I’m now operating almost as a local Chinese company. I think it shows good responsibility to say I am also enriching the community [and] the economy by sourcing some of my raw materials in the country,” referring to insurance as one of the raw materials of a business.

Referring to the additional competition on a program, Ellis said, “If I have a program that needs 20 or 30 carriers and I can bring in a 21st or 31st carrier to compete on that program, perhaps everyone else’s pencils become a little bit sharper.”

Still, Ellis said property insurance pricing isn’t coming down.

“Any time you have something that is relatively new, there is some nervousness around it. But I don’t think it’s necessarily valid,” he added. “These [Chinese] companies are very well-capitalized. They’re fully rated by the same rating agencies.

“These companies are not faint of heart,” he continued. “They’ve been around a long time in the insurance community. All they are really looking to do now is expand beyond their borders and start writing some of these accounts with which they’re fairly familiar because they’re so large and global,” he said, agreeing that a desire to diversify is a driver for Chinese insurers.

“They wouldn’t be making this push into this marketplace if they were anticipating running for the hills the first time a loss happens,” he said.

Berkshire’s Opportunistic Plays

Peter Eastwood, Berkshire Hathaway president who in late April set out to launch the company’s new specialty insurance company along with three other defectors from AIG, said Berkshire Hathaway Specialty Insurance is also in the property insurance business – and the casualty business for the long haul.

Distinguishing the new operation, now 40 employees strong, from Berkshire’s existing flagship National Indemnity, Eastwood said not to count out Berkshire’s role as a just-in-time capital supplier.

Referring to Krauze’s comment about Berkshire Hathaway’s market reputation of being opportunistic, Eastwood said, “Everybody in this business should continue to think about Berkshire Hathaway being that market participant that you’re used to – Ajit Jain and his Berkshire reinsurance operation being in the market and providing that capital when it’s most needed.” He noted that National Indemnity and its five affiliated companies have more than $100 billion in policyholder surplus.

“In addition to that, a team of people led by me and my colleagues will operationalize that $100 million of capital and have it in the market in a more permanent, long-term, focused way,” he said.

Eastwood responded to an audience participant who reviewed a string of property-catastrophe losses and poor underwriting results in the past decade and asked how Jain could have been convinced that entering the insurance market was a good idea: “It’s been a challenging 10-12 years,” Eastwood agreed. Still, “I do think that over the long term, as you look at the market cycle – if you stay in the business for the long term, you’ve got the ability to generate adequate returns to justify having the capital [in] the business.

“We have a belief that we can be in the business for the long term,” generating “acceptable returns over the multiple cycles, over a long period of time, ultimately to the satisfaction of customers.”

Capital Permanence

Commenting on the transience of alternative capital in the property-catastrophe reinsurance market, Eastwood said mechanisms that deliver that alternative capital for catastrophe protection are here to stay.

Catastrophe bonds, sidecars and industry loss warranty programs will be the means of capital formation “on a going-forward basis,” he said, contrasting past times when private equity firms created reinsurance companies when market opportunities arose.

Investors like the fact that the capital “can get in, can get out,” without the hassle of creating an entire reinsurance business and the related infrastructure, he said. “That capital formation is going to have a market-cycle dampening effect.”

Going forward, Eastwood said, “we’re not going to see the pronounced spikes that we once saw, or the pronounced troughs … that proposition is part of what’s the driver behind me and my colleagues operationalizing a [strong] balance sheet and being in the business in a more permanent way.”

McNamee, who noted that pension funds in search of yield are fueling growth in capital market alternatives to reinsurance, said the money that’s pouring in is transient.

“We don’t see it running away because there’s a loss in the marketplace. We see it running away because interest rates rise,” he said.

McNamee asserted that lower reinsurance costs resulting from the capital markets competition are not filtering down into insurance pricing.

“While reinsurance is a factor, it is not a real driver of change in the marketplace,” he said.

Marsh’s Ellis is unconvinced. “That’s bunk,” he said, reacting to McNamee’s assertion that reinsurance pricing is not a component of the overall price that carriers charge their insurance customers. “If you’re manufacturing clothing and the cost of the material is going up, [then] the cost of the clothing is going up too. “If the [reinsurance] cost is going down, you should be reflecting that. If you’re not, you’re making higher profits … It is definitely going to impact pricing going down. The question is when, not if,” he said.

Ellis reported commercial insurance property rates are “flat to down a couple of percentage points, unless you’re in a very problematic area, such as low-lying areas of the Northeast impacted by Superstorm Sandy.”

Referring to underwriting and pricing changes in the wake of Sandy, specifically moves to cut flood sublimits and push deductible levels higher, Ellis called for insurers to practice more consistency.

Ellis said that knee-jerk post-event reactions by insurers give the industry a black eye.

“Right now, earthquake insurance is relatively available. That’s until the California quake comes. Then they’ll all be up here telling you how difficult earthquake insurance is,” Ellis concluded.