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Monday, 20 February 2012

P&I market hardening as claims rise and solvency rules bite

By Stuart Collins
Email Author

Ship owners could face several years of premium rate increases as the sector prepares for another potential downturn and tougher solvency regulations.

Protection and Indemnity (P&I) Clubs, which provide liability insurance to the bulk of the world’s shipping fleets, have enjoyed a profitable 2011. However, contrary to the soft marine insurance market, P&I Clubs continue to raise rates, citing deteriorating claims and tough new capital rules under Solvency II.

The P&I sector enjoyed a fantastic year ending February 2011, according to Ben Abraham, Head of Global P&I, Marine at Willis. With investment returns of 6.5% and a good year for claims, the P&I Club sector produced a record underwriting result and its highest ever recorded level of free reserves, he said.

However, volatile equity markets and reports of increasing claims in 2012 are likely to lead to an overall close to breakeven result for the financial year ending February 2012, said Mr Abraham. In response, clubs are taking a more cautious approach to the renewal, calling for an average rate increase of 4.25% in February 2012 compared with the 3.42% average rise in 2011, he said.

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Clubs are seeking increases to make up for a lack of investment returns, as well as to reflect inflationary pressures on claims and tougher capital rules under Solvency II, according to Simon Schnorr, Head of the P&I team at Aon.

“The key issue for P&I Clubs is the lack of investment income. They have become more conservative in their investment strategies with the financial market turmoil and have become more cautious in their underwriting because they can no longer rely on investments,” said Mr Schnorr. “And, although P&I Clubs have healthy free reserves, they don’t want to see their capital eroded ahead of Solvency II,” said Mr Schnorr.

In the absence of large catastrophe losses or a spike in claims, ship owners are likely to face a similar situation next year, said Mr Schnorr. “I would cautiously expect we will see clubs looking for general increases of between 0–5%,” he said.

Clubs are keen to maintain free reserves at their current high levels, in part to maintain financial strength ratings and in anticipation of higher capital requirements under Solvency II, said Mr Abraham. But they are also concerned with the uncertain direction of claims trends.

The medium-term challenge for the P&I sector will be when shipping activity picks up, said Mr Abraham. “If claims frequency were to rise and we continued to see the current levels of severity then we would see claims increase quickly for P&I Clubs.”

P&I Clubs have been reporting a varied picture of claims experience in the current year—ranging from modest inflationary increases, to double digit increases in the cost of claims, suggesting increasing volatility in the cost of large claims for some clubs, said Mr Abraham.

The increase in premium rate being sought at the February renewal is mainly to compensate for claims inflation, said Rolf Thore Roppestad of Gard, which is asking for a general increase of 5%. “There has not been a dramatic upwards trend in claims since the bad years of 2006/07. But while 2008/09 were good years there has been an increasing claims trend with higher severity and lower frequency. Each claim is getting more expensive.”

In particular, there has been a significant increase in collision claims, caused both by collisions between ships, as well as contact with fixed or floating objects, especially when entering or leaving port, said Mr Roppestad. Such claims were, as per October 2011, estimated to account for 41% of claims in the International Group pool in 2009 and 45% in 2010, compared with 20% in the three previous years.

The shift in collision claims reflects the increasing cost of each claim, said Mr Roppestad. “If you hit a quay in Latin America, for example, it costs more today than in the past because of increased levels of compensation and the effect of the weaker dollar on exchange rates,” he said. “What we see is a creeping development that is adding a few percentage points to our costs each year.”

P&I Clubs are pushing for higher premium rates at a challenging time for ship owners. “There are tensions in this renewal between the owners’ pressure to keep insurance costs down, and the clubs efforts to push up rates,” said Mr Abraham.

It is a difficult time for ship owners, but Gard’s 5% general increase is on the low side of what is technically correct, according to Mr Roppestad. “We run the P&I account at below costs [above 100% combined ratio], and we can do this because the P&I business area is supported by our commercial business,” he said.

However, the investment market is generating close to zero returns, said Mr Roppestad. “We can’t rely on investment returns and we expect a difficult market for years to come. Long term, if interest rates remain low then we may have to tighten up the technical result and reduce our 105% target combined ratio,” said Mr Roppestad.

A global economic downturn could result in lower premium volumes and exposure for P&I Clubs if ship owners were to suffer financial difficulties and be forced to close, said Stale Hansen of Skuld.

“Gross tonnage is still growing but the pace of growth has been slowing. So we expect the P&I side to slow down but we can compensate through our non-mutual products, such as our charterers business and our Lloyd’s syndicate,” he said.

In the lead up to the 2008 downturn, ship owners had built up financial buffers after years of growth and strong profits. But this time around those buffers are lower, said Hansen.

Although insurance is the last thing ship owners stop paying for, there will be more of a focus on outstanding premium and slower payment, he said.

“Long-term relationships are valued in difficult times and we see that in this renewal,” said Mr Roppestad. “Contrary to expectations, we have seen some early renewals with large owners in appreciation of the long-term relationship, the financial solidity and stability.”

As new builds continue to come to the market and as older vessels are scrapped, P&I clubs are seeing an increase in the ‘churn’ effect. “This is a challenge for the P&I sector as older vessels have more mature premiums while rates for new builds are highly competitive,” said Mr Hansen. “Skuld emphasises the appropriate rate for an individual account, including new builds. So we would rather let some potential new clients go to our competitors rather than underwrite the business at overly competitive rates,” he said.

Another challenge for the P&I sector is the looming Solvency II Directive, due to be implemented in 2014.

Solvency II will have an impact on the competitive landscape, Mr Roppestad told Commercial Risk Europe. “It will become increasingly challenging to operate and we will continue to see the smaller players in the marine market go to the larger insurers.”

Solvency II is also a driver for diversification, said Mr Hansen. “Solvency II is a trigger to diversify into more product portfolios to reduce solvency capital requirements and improve risk exposure,” he said.

In recent years, Gard and Skuld, among other clubs, have diversified into non-mutual lines of marine business. For example, both clubs now offer energy insurance and Skuld opened a Lloyd’s syndicate in 2011, the first P&I Club to do so.

“Skuld has been preparing for Solvency II for some time. We first introduced ERM in 2003 and have already built an internal model. A lot of that work will help with our Solvency II preparation,” he said. “Our strategy has been to build sufficient capital, so we will be well within Solvency II requirements and will not need to raise capital.”

Solvency II could also trigger consolidation in the P&I market, which has historically proven challenging. “Solvency II could be a factor if the members of smaller clubs find that it is more expensive to fund Solvency II requirements. Smaller clubs have the strong support of their members, but in the end there will be some consolidation from Solvency II,” said Mr Hansen.

Most P&I Clubs have strong capitalisation on the back of good results in 2011, said S&P analyst Ali Karakuyu. While the financial strength rating of many European insurers are under pressure, several P&I Clubs are currently viewed favourably, he said.

Gard, Skuld and the Swedish Club are all currently viewed positively by S&P, while the American Club was upgraded last year.

“The favourable outlook for clubs like Gard is unusual in these times but it reflects strong underwriting and improving risk management that has allowed some clubs to buck the wider trend,” said Peter McClean a credit analyst at S&P. “P&I Clubs are also differentiated by their competitive position, that enables them to apply general increases of between 3–5% when the rest of the non-life sector is generally challenged to maintain flat rates,” he said.

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