LETTER TO THE EDITOR

Hope for the best, plan for the worst and prepare to be surprised

Wednesday, April 13, 2005

Dear Sir:

As the Managing Director of Royal Star Assurance Ltd, a company that currently insures approximately ten percent of the property and casualty insurance market in the Cayman Islands, I have been following developments within the insurance market post Hurricane Ivan with a great deal of interest and, quite frankly, a great deal of concern.

Comments have been made by certain participants in the insurance market that the reason why Ivan caused some insurers to exceed their reinsurance coverage was that it was an event of unforeseeable magnitude and effect. This is simply not the case. A catastrophic event like Ivan was, is and always will be entirely predictable.

The experts in such matters believe that a hurricane like Ivan could occur once every 200 years. This does not mean that it will be another 200 years before we see an Ivan-like event again. What it means is that five similar events are likely to occur in a 1000 year period.

Although Ivan occurred in 2004, the likelihood of a similar event to Ivan occurring in 2005 is the same as it was in 2004. Was Ivan the worst-case scenario? Absolutely not, an event that is expected to occur once every 500 years will be significantly worse.

While I realize that this will be incomprehensible to most, unfortunately this is the reality. Also, a similar event to Ivan in the future could, in all probability, be worse given that rising seawaters could result in a greater tidal surge.

When buying reinsurance an insurer uses computer based catastrophe models that estimate what the financial losses will be from hurricanes of differing tracks and severity. Based on the results of the models, they then determine the amount or limit of reinsurance that they will buy.

A key consideration in such decisions is the extent to which the cost of reinsurance negatively impacts profitability. An additional and important consideration in this thought process is the willingness and ability of shareholders to inject capital in the event that claims exceed the amount of reinsurance cover that has been purchased.

Shareholders who have the ability and willingness to inject capital may elect to buy less reinsurance and maintain higher profitability levels. Unfortunately, after Ivan, there were some companies that had claims exceeding their reinsurance coverage. The shareholders of some affected companies have injected additional capital to meet their policyholders’ claim whilst the shareholders of others have not, leaving their policyholders in a most difficult position.

Given what has happened in the Cayman insurance marketplace following Ivan, and more particularly the fact that as a number of insurance companies writing property casualty business in the Cayman Islands exceeded the levels of reinsurance purchased, observers could be forgiven for drawing the conclusion that there are major structural problems within the insurance industry in the Cayman Islands. In my view, this is not the case.

Take Royal Star Assurance as an example, and there are others. Royal Star did not come close to exceeding the amount of reinsurance that it had bought, primarily because it did not, and still does not, believe that Ivan is the worst case scenario.

Unfortunately the cost of adequate catastrophe reinsurance is very expensive and there is no alternative but to pass this cost on to the consumer, thus making the cost of insurance to the public more expensive compared to those companies that chose to buy lower levels of reinsurance. It is disappointing to see that some of the companies, which chose to maximize profitability by purchasing lower levels of reinsurance and have subsequently ended up in financial difficulties after Ivan, now seek to attribute these problems to a lack of foresight within the entire industry.

When it comes to the business of insurance, insurers should hope for the best, plan for the worst and prepare to be surprised. The most important of these is planning for the worst, something that not all of the insurers operating in Cayman appear to have done when purchasing reinsurance for 2004.

Steven A. Watson,
General Manager
Royal Star Assurance Ltd

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