The Satellite Insurance Market and Underwriting cycles

Comments by

J. François Outreville

ARIA Annual Meeting, Québec, 2007

Cycles: what we know!

– Large losses, investment, and general economic shocks occur, affecting insurer profits and capital

– Institutional (regulatory) and accounting lags produce a cyclical profit pattern even under rational expectations (Cummins-Outreville,1987)

– Due to information asymmetries and other imperfections, capital does not flow freely into and out of the insurance market (capacity constraints: Niehaus-Terry 1993, Winter 1994, Gron 1994)

Cycles: what to explain?

– Shocks are not “causes” of cycles – a rational expectations market could exist with shocks but no cycles

– The market is characterized by “real cycles.” i.e., alternating periods of

• Hard markets – high prices and limited coverage

• Soft markets – low prices and abundant supply

Cycles: other explanations– Risky debt: (Cummins-Danzon 1997) shocks drive

insurers away from optimal capital structure, leading to supply shifts until

• Capital is restored and/or

• External capital is raised.

– Reinsurance price: (Meier-Outreville 2006) reinsurance is preferred to external capital if available at an affordable price.

• Reinsurance allows a primary insurer to increase its premium volume with a given amount of capital. This will be reflected in more capacity.

Reinsurance in this paper

- Satellite Insurance is a business for reinsurers• Companies underwriting satellite insurance are among

the largest reinsurance groups

- Capacity in the satellite insurance rate model is influenced by the overall capacity of the reinsurers• Return on equity and change in equity may be relevant

variables

Reinsurance price cycle

- The market for Reinsurance (Cummins and Weiss, 2000).

- Property reinsurance business is subject to price cycles.

- Price fluctuations in reinsurance can lead to either an increase or a decrease in insurance prices and premium volume.

Reinsurance Price Index

0

20

40

60

80

100

120

140

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

Reinsurance

Reinsurance price cycle

- Price Index- Period 1980-2002 result 8.73 and no significant trend

(Meier-Outreville, forthcoming)

- Satellite insurance- Minimum RoL 13.73 no trend

12.36 with significant trend

Reinsurance Price Indices

0

50

100

150

200

250

300

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

SwissRe Index

Guy Carpenter

The Reinsurance Cycleand Return on Equity

-40

-20

0

20

40

60

80

100

120

140

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

Reinsurance

Return on equity

Change in equity

Suggestions

- The reinsurance price cycle (and change in equity) certainly impact the satellite insurance capacity.

- Capacity may be negatively related to the concentration level of the reinsurance market in satellite coverage.

- Capacity may be related to the overall financial markets (rather than only stock market performance)

Conclusion

• This is a useful paper that extends our understanding of– Relationship between price and capacity (simultaneous

equations)

– The impact of capacity constraints on cycles

• Future work– Better understanding of information asymmetries and

barriers to capital flows in insurance markets

– Relationship between insurance lines in the reinsurance portfolio