By STEVE TUCKEY, who has written on insurance issues for a decade for several national media outlets
"There may be some nervousness, but it is nothing really to scare the horses," says David Simmons, London-based research director for Aon Benfield. If he is correct, then the horses may be the only fearless mammals out there today as reinsurers try and make sense of the new world order in 2009.
Reinsurance outlooks in normal times traditionally look at factors such as natural catastrophes in the past year, along with where in the pricing cycle the industry currently stands. But beginning with the fall of Bear Stearns in March of last year, followed by the beat-downs of Citigroup and American International Group and the death of Lehman Brothers, nothing about the events of 2008-09 can be thought of as approaching normal.
When so respected a business guru as Warren Buffett abandons his usual cautious optimism to declare as he did last month that the economy has "fallen off a cliff," devising an outlook for the next nine minutes, no less the next nine months, presents unique challenges. Have all the rules changed, or are they merely more critical to follow than ever before? Those are the questions pondered by insurers and reinsurers in this new environment.
Simmons estimates that reinsurer capital declined between 15 percent and 20 percent in 2008, with 90 percent of that due to the credit and liquidity crisis and with the balance flowing from catastrophe losses.
While Hurricane Ike last September ended up as one of the most destructive catastrophes in history, Laline Carvalho, director for Standard & Poor's, says that "the impact was relatively small compared to the losses on investment portfolios."
Carvalho notes though, so far, no significant downgrades have appeared in the sector, and it remains the only one with a stable outlook.
"Although the resultant capital erosion has been dramatic, reinsurers appear to have absorbed within our estimates the excess capital the sector has built up, principally during the past two successive years of record profitability," she says.
And most reinsurers enjoy a fairly strong liquidity position. "They have a strong cash flow position and have very little debt coming due in the next couple of years," Carvalho says.
"Thankfully, the credit and liquidity crisis follows strong industry profits in 2006 and 2007," Simmons says.
"Nonetheless, many reinsurers have seen their capital buffer materially eroded. This has reduced the margin for error, particularly in light of the increased uncertainty and cost of new capital if the need were to arise," Carvalho warns.
Simmons agrees that, all in all, the reinsurance market is functioning in a fairly normal manner. But all that could change with a further deterioration in economic conditions, after which ratings agencies may rethink nearly everything.
"They could suddenly change the rules of the game, but I suspect they won't," he says. "But I don't have any expectation that the whole (reinsurance) market is going to suffer a systemic downgrade."
Nonetheless, a $50 billion-plus industry loss in these dicey times would create unique challenges in raising replacement capital, Carvalho adds.
A.M. Best analyst Devin Inskeep notes that, at the first surfacing of the subprime crisis in August of 2007, some reinsurers initiated buyback programs that in hindsight may not have been the best deployment of capital in light of the opportunities that lay ahead.
"The overarching issue facing insurers now is that the wells are drier going into 2009, as capital is not expected to flow into the industry in a meaningful way," he says. "This represents a different position compared with other cycle inflection points, following the World Trade Center and Hurricane Katrina events when capital poured into the segment."
UPSIDE OF CRISIS
The overall financial crisis could of course present great challenges to the reinsurance industry as it copes with a severe loss on the asset side of the balance sheet like most industries. But it also brings the industry a unique opportunity as reinsurers become a functioning capital markets outlet available to insurers looking to shore up their own balance sheets in the aftermath of the turmoil.
Simmons notes that the credit crisis has hit primary insurers much harder than reinsurers, with the former group suffering a decrease of capital of up to 30 percent.
"Despite this material erosion of accounting, economic and ratings agency capital, insurers have not yet materially changed reinsurance buying," he says. "Only in limited circumstances have we seen the more stressed balance sheets driving additional reinsurance buying."
In fact, some cedants have tried to offset increased reinsurance prices through higher retentions. But all that could change as the rules get rewritten.
"Although it hasn't quite yet materialized, an intuitive increase in demand for reinsurance capital may result from insurer capital erosion and lack of capital alternatives due to the decline in insurer valuations and the disruption in the debt markets," Simmons says. "Reinsurance remains one of the only functioning capital markets for investors."
Insurers may face new pressures from ratings agencies to restore capital, along with enhancements to enterprise risk management programs and new capital models that may lower risk appetites and lead to offloading of retained risk, Simmons adds.
Peter Hearn, chief executive officer of Willis Re, sees the gradual decline in primary insurers' appetite for reinsurance starting to abate.
"Now, cedants are exploring buy-downs and other reinsurance mechanisms in order to protect and enhance their capital positions," he says.
In addition, he sees a shift in the manner in which cedants select reinsurance partners.
"With third-party ratings no longer sacrosanct, insurers are seeking to use portfolio diversification to mitigate their counterparty exposure," Hearn says. An increased syndication of risk has resulted with a number of reinsurers now able to obtain pieces of the pie that were once the sole province of the large players, Hearn adds.
Carvalho says that cedants are already trying to pass more business on to the reinsurance marketplace. "They may not be successful in doing that because a lot of the global insurers this year are really looking to keep their exposures the same or down and with better pricing. So you may see an increase in the premium volume position, but that does not mean that exposure has increased."
Thus, reinsurers will have to see pretty "dramatic" price increases before increasing their exposure or else an improvement in the capital markets that lets them shore their positions "at a reasonable cost," Carvalho says.
Simmons agrees that, during the January 1 renewal season, cedants were generally able to renew their contracts with flat or modest price increases, but getting new business written proved to be more of a challenge; one sometimes not met.
As for the actual numbers, property business in catastrophe zones saw 15 percent or higher increases while rates in noncatastrophe zones saw increases between 5 percent and 15 percent. Casualty business for reinsurance did not move much.
"But at least it stayed flat," Carvalho says.
The industry does look forward to further rate increases in the June and July season.
Reinsurance executives normally spend their years nervously eyeing the Weather Channel for divinations into their fortunes. But this year there will be a lot of surfing to business channels as they try and figure out how far off of a cliff the economy fell and the prospects for it to pick itself up, dust itself off and start all over again, as President Obama put it in his inaugural address.
April 15, 2009
Copyright 2009© LRP Publications