Two days late of "All Fools' Day" Scandinavian marine underwriters convened in Oslo last week for the Central Union of Marine Underwriter's (CEFOR) annual meeting. The meeting is most noted for presenting annual statistics from the CEFOR database, encompassing almost 50% of the world fleet's gross tonnage. This year the statistics show a claims development that could be mistaken for an April hoax. In this environment Norwegian underwriters can also note that the Norwegian market has passed Lloyd's of London in terms of hull premium volume. Any attempts of celebrating this pyrrhic victory would suggest that "all fools' day" came twice to Norwegian insurers this year...
CEFOR has a proud tradition of reporting the ludicrousness of the Hull & Machinery insurance market. Anyone familiar with the market will know this to be a fairly simple task. For years the development and level of premium rates were the main source of entertainment. From 1995 to 1999 premium per vessel dropped by a stunning 60%. In the same period, and several years thereafter, claims per vessel were remarkably stable, with no signs of significant trends. It should come as no surprise that underwriting results changed from positive to negative during these years of diving premiums. The period serves as a nice illustration of the industry's remarkable ability of producing self-inflicted losses.
In the good old days the remedies for insufficient premium rates were several, and the possibility of a quick fix well at hand. Firstly, there was "always" a reinsurance company to pass the losses on to. The reinsurance covers of the past included quota shares, "working" excess of loss layers and stop loss covers. The effect of the latter was often surprisingly literal... Secondly, the direct premium could be increased fairly dramatically. From 1990 to 1993 CEFOR loss ratios dropped from 228% to 47% following increases in deductibles and premium rates. Disregarding the claims development, this implies an effectual premium increase of 3-400%. If neither reinsurance nor premium hikes solved the problem, the underwriter could always move on to another of a large number of marine insurers. You can always shut down a company, but you can't shut down an underwriter...
In the current market, new challenges face the underwriters. At this years annual CEFOR meeting, the focus of attention was on the claims rather than the premium. The years following 2002 have seen a doubling of claims per vessel. All vessel types, claims types and claims of all sizes are affected. The current losses are thus not quite as self-inflicted as the losses of the past. The claims surge should not come as a complete surprise however. With steel prices tripling, vessels' operating costs increasing by 50%, the US dollar weakening and vessel values increasing strongly - an effect on claims was only to be expected. To some extent the model-averse marine insurance community might have fallen victim of the few models it embraces. Firstly, the practice of responding to value increases by only adjusting the total loss element of the premium led to systemic under-pricing when vessel values rocketed. Secondly, the gradual influx of actuarial rating models in recent years might have increased the insurance industry's habit of navigating by rear view mirror. Normally this art of navigation is better than no navigation, but when the road turns the method has its shortcomings. Thirdly, complex models of profit sharing are increasingly popular. Profit commissions, continuity credits, no claim bonuses and prompt payment clauses (sic!) are combined in ways only limited by the considerable imagination of the broker. When it comes to fixing prices, many of these clauses seem intellectually inspired by the lyrics of "Master of the House" (Les Misérables). The consequence is bad turning to worse in terms of underwriting profitability. In addition to these new perils of the market, the underwriters' relentless belief in fleet statistics fails to address the problem. It is a well known fact that the vast majority of fleets show good results, even if the market results are terrible . To the underwriter it might seem unproblematic that the typical fleet rather shows an 80% loss ratio than a 50% loss ratio - as long as a profit is made. For an insurance company, whose business model is based on many fleets with good statistics paying for the few fleets with bad statistics, the consequence is disastrous.
This time the quick fix is not ready at hand. Reinsurers are few and not very far between and are no longer a source of salvation from the misfortune of the direct market. Furthermore, prospects of large premium hikes in the direct market seem surprisingly poor. The profitability in other lines of insurance is good. Even within marine there are several profitable sub-lines. To many market players the problems of the hull market are thus not fully recognised. Some companies still regard hull as an attractive source of diversification, given its independence from other lines of business. This might be fuelled by the proposed Solvency II regulations -giving great credit to diversification. Diversifying by adding uncorrelated, but unprofitable business is a questionable strategy and is certainly not good news for the hull market as such.
CEFOR statistics are sometimes met with scepticism. How can a market survive with results as the ones reported by CEFOR, and why is the CEFOR average always worse than the individual results of all the reporting companies? No doubt the same will apply this year. Weekly you read about companies regarding marine as a profitable niche or new companies being set up to outsmart the losers of the past. At least up until last year raising money and attracting experienced employees to these ventures was also straightforward. Irrespective of claims statistics, a mere glance at the outside world should give rise for concern, however. Increased steel prices, weaker dollar, lack of officers and crew, congested waters, lack of ship yards, poor quality of repairs and new buildings are all facts with inescapable consequences. The times ahead will henceforth be interesting for anyone with an interest in marine insurance.
Christian Irgens (MBA, MSc)
Appointed Actuary and Business Intelligence Director for the Norwegian Hull Club and former chairman of CEFOR's Statistics Forum.
[1] Ref. Lloyd's List 19 September 2006: "Why good statistics are just a myth"
