Swiss Re Chief Underwriting Officer Warns of Casualty 'Bubble'

Interest rates, the threat of inflation and underpriced casualty business in the insurance industry are all issues on the mind of Swiss Re's Chief Underwriting Officer Brian Gray.

"The biggest impact of the recession from an underwriting perspective has been the big drop in interest rates. That certainly has had an impact on the long-tail lines of business and moves the economics quite a bit," Gray told BestWeek.

With interest rates lower than the recent past, insurers have to rely more on strong underwriting to turn a profit because they aren't likely to make up any underwriting losses on the investment side.

However, the long-tail lines in the industry have not reacted fully yet to the drop in interest rates, said Gray, who is based in Zurich, but recently visited Swiss Re's Manhattan headquarters.

"The break-even price has to have more contribution from underwriting to compensate for that. But the underlying casualty prices are going the other way -- they are dropping," Gray said.

Lower pricing, combined with higher loss trends and the potential for higher inflation in coming years "leaves us to believe that some of the assumptions being made about profitability around casualty will probably turn out to be too optimistic by the time the business runs out," he said.

"We fear there is a bubble forming in the casualty market and the longer we go without correction, the bigger the bubble gets. At some point, we fear there is a risk that that it will pop and leave a big sticky mess on those companies or participants that have not been able to maintain discipline," Gray said.

He said Swiss Re wants to be in the casualty reinsurance market for the long term, "but it is a challenging market to earn a living in right now."

Gray said he's also concerned that inflation may rise. "Not in the near term, not the next six to 12 to 18 months, but a lot of policies that we are writing now will run off in three or five or eight years and therefore be subject to whatever inflation is out there then," Gray said.

The entire casualty insurance industry has benefited from stable or even falling inflation rates in recent years, he said.

"Year after year...the inflation that affects the claims settlement has often turned out to be just a little bit less than what was assumed at the time when the business was originally priced. The potential danger is over the next decade, if that [trend] reverses and we wind up with claims settlements that are subject to inflation that is two or three or five points higher than is currently built into the cost. There is no certainty that that will happen, but it is a risk," Gray said.

In addition to inflation, Gray said regulatory issues are becoming an emerging risk. He cited a bill proposed by U.S. Rep. Richard Neal, D-Mass., that would change how offshore reinsurers are taxed.

"There is some danger given the economic circumstances and deficits that countries will turn to more protectionist tax policies, which could impact the whole industry," Gray said.

Swiss Re is the largest global reinsurer by ranked by 2008 gross reinsurance premiums (Best's Review, September 2009).

Swiss Reinsurance Co. Ltd. currently has a Best's Financial Strength Rating of A (Excellent).