Catastrophe Buyer Q&A: Tower Group's Rob Flannagan

More than a year after earthquakes rocked New Zealand the local insurance industry is still reeling from major reinsurance rate increases and changing capacity.

RiskMarketNews spoke with Rob Flannagan, Group Managing Director of Tower Group, about the reaction of the local insurance industry.

Tower Group’s Rob Flannagan
 
RiskMarketNews: How is your reinsurance renewal process going a year after the earthquake? Has your catastrophe modeling approach changed?
 
Rob Flannagan: We’re still going through our process. As a consequence of the earthquake, we’ve obviously revisited the modeling and redesigned our program based on new science.
 
For example, the Christchurch earthquake — in simple terms — wasn’t meant to happen according to the existing science at the time. Everyone knew there were fault lines but the modeling gave almost a zero rating as to the likelihood of the major quake.
 
And yet we had a major quake. Also, the second quake was much larger than the first one and that, I think, is almost the first time that’s ever happened. So then you have to say, “Well how does that affect your modeling for other areas of the country such as Wellington which has always been regarded as a higher risk?”
 
As a consequence of those issues we’ve changed our modeling and the whole program has been redesigned and increased. 
 
RMN: How has this translated into pricing the risk in the reinsurance market?
 
Flannagan: We’ve found that there appears to be plenty of capacity out there to fill our program and we’re getting quotes as we speak. But clearly the reinsurers are wanting higher rates and so there is a lot of pressure. We expect our rates to go up quite a bit and we understand that and respect that. 
 
The big problem for us as a small insurer is on the lower layers of reinsurance. There is a lot of pressure to have much higher excesses. When you’re a smaller player that makes renewals hard. But that’s just part of the way it is. 
 
At the end of the day we expect our program to be filled. The rates will also be determined what happens in the Atlantic in terms of the hurricane season between now and the end of September.

RMN: How is the reinsurance price increases translating into you customer base?
 
Flannagan: We’ve got to pass those rates on as an annual cost on every insurance contract. The question becomes how do you get that into the market? 
 
First, we can only increase rates on the renewal of each contract, so that really means you’re just recovering the flat cost at first. That’s problematic because reinsurers want their return on capital immediately, but of course it will take us 18 months to roll that adjustment through out market. 

This is quite a paradigm shift for the New Zealand insurance industry because most of us never made a lot of money out of the property portfolio over the last seven years. There was a number of factors for that, but mainly because distribution is driven by the banks and they want a reasonable commission. That makes the business relatively marginal. But as an industry we’ve sort of tolerated that.
 
Now we’ve got to change because not only do we have to put the reinsurance cost through, but we also want to restore our margins to get our return on capital just as everyone else does. 

I think it’s a paradigm shift for the industry and it has got to reinvent itself.

I think it’s a paradigm shift for the industry and it has got to reinvent itself. And what we don’t know what the actual costs of the reinsurance will be until the end of our financial year when the contracts are signed with the reinsurers. 
 
The question for the industry is how do you manage the big increase in cost, and over what timeframe can you can manage it. And at the end of the day making sure you retain your customers on the way through
 
RMN: Given the current stress in the traditional reinsurance markets have you considered alternative risk transfer methods, such as catastrophe bond?
 
Flannagan: Quite frankly, I’ve never considered that. 
 
Actually, have not considered it, so I couldn’t really kind of comment. And we’re not getting any pressure to consider anything else. That could all change in a hurry, but I haven’t even thought about it. 
 
RMN: What would you think is the biggest challenge for the New Zealand insurance market given the catastrophic risk that has gone through the past few years?
 
Flannagan: The big challenge is the rebuilding of Christchurch because that’s going to be a three to five year process. That just puts a lot of resources and a lot of effort in managing the process together with the high emotional level of dealing with the clients through this stressful time. 
 
The second challenge is purely to retain our businesses and to return on capital without losing our customer base at the same time.
 
The question is: “Do you think the customer base will respond? Will they understand the situation of the insurers in passing on these sort of costs now?”
 
Yes, they understand. But when it comes to increases, they have difficulty with it  especially in a flat economy  it’s also  a very emotional issue
 
RMN: Do you feel a lot of work needs to be done on understanding what New Zealand’s risk are to quake? Does the whole system need to be redone? Or do you think this is sort of within possible expectations?
 
Flannagan: Well, the science is the science, and the science has been found wanting. Not only in Christchurch, but it has also been found wanting for Japan as well. My understanding is Japan couldn’t have an earthquake greater than 8.4, but then they had an earthquake of 9. So you got to say, “How did that happen?” And that’s what I think I’m nervous about because the  science  was wrong.
 
Modeling only informs your decision as an insurer. You have to make adjustments on a lot of factors. At the end of the day, it’s always gut feeling. And that’s not a great way to do it when you talking such big numbers, but it just informs your decision.
 
Will it get better? It will get better in time, but earthquakes, weather and nature in general humbles you.