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By STEVE TUCKEY, who has written on insurance issues for a decade for several national media outlets

(This is the lead story from our 2009 Reinsurance Power Broker^TM package. Click on the following link to access the profiles of this year's Reinsurance Power Broker^TM winners.)

The financial crisis has also treated them better, at least in relative terms, than their counterparts in the primary insurance sector. A recent Aon Benfield Outlook reported that reinsurer capital suffered a 14 percent depletion in 2008, on the low end of previous 15 percent to 20 percent estimates. This compares with the estimated 25 percent to 30 percent declines suffered by the primary sector.

The secondary industry also looks forward to a new era of more nationalized regulation, although the exact contours of that have yet to emerge.

Speaking at a recent industry event, reinsurance leaders gave themselves something of a pat on the back for not going the late '90s route of giving away the store, both in terms of price and terms and conditions.

W. Marston Becker, chairman of Max Capital Group Ltd., said the reinsurance industry deserves a lot of credit at this point in the cycle. Things are nowhere near as bad as they seemed a year ago. "A year ago we were reading about nothing but significant declines in the casualty business," he said. "Today you read about some mixed rates with some down and some flat."

He noted that real rate hardening has never come without a steep rise in the combined ratios, which so far has yet to surface.

He attributed this relative strength to a better monitoring of terms and conditions, better risk management, and an industry trying its darndest to remove "the peaks and valleys out of the cycles without eliminating them entirely."

John Charman, president of Axis Capital, agreed that the current property/casualty pricing weakness lies not with the secondary market.

"I am much more concerned about the failure of the primary market to properly understand the weakness of the underlying pricing of a great many of the product lines," he said.

As seen in reinsurance pricing as of April 1, according to the Aon Benfield report, demand continued to exceed supply for key aggregate zones such as the U.S. East Coast, and that meant upward pressure on rates. In addition, shortfalls in capacity continue to occur in property-catastrophe retrocession programs.

And for the more significant Jan. 1 renewals, Standard & Poor's reported that that reinsurers enjoyed 15 percent to 30 percent premium rate increases for U.S. catastrophe-exposed property risks. Meanwhile, non-CAT U.S. and European property risks rose slightly less at between 5 percent and 15 percent.

Casualty reinsurance rates have so far remained flat for 2009, although that is an improvement from the declines the lines have seen for more than four years. Laline Carvalho, S&P reinsurance analyst, said the need for casualty line increases remains acute.

"We believe it is unlikely that the unusually low frequency and severity of losses seen in many casualty lines during recent years will continue," she said. Recession-inspired directors' & offiers' (D&O) and errors & omissions (E&O) lawsuits could spur an increase in both severity and frequency, she added.

"Casualty reinsurance pricing remains a wild card, but in our opinion this line is unlikely to see material rate improvement through the remainder of 2009," she said.

Reinsurers can pat themselves on the back as they lead the pack when it comes to high scores for enterprise risk management, according to Carvalho. About 43 percent of reinsurers have strong or excellent ERM scores, and 57 percent of them had scores that were deemed adequate, according to a recent S&P survey.

Catastrophe-bond issuance generated some steam early in the summer, with a total $1.22 billion in risk announced for this year so far. The 2008 total of $2.7 billion represented a 62 percent drop from the previous year, stemming in part from soft reinsurance pricing and general market turmoil starting with the near collapse of Bear Stearns in March 2009 and continuing with the meltdown of the broader market last September.

The increased bonding so far this year has focused on U.S. catastrophe peril and reflects some tightening of the reinsurance market. The spike has generated some surprise in that insurers are said to be paying 50 percent more for catastrophe-bond protection this year, while reinsurance pricing increases have yet to exceed 25 percent. However, catastrophe bonds often provide three-year coverage and are 100 percent collateralized up front, one expert noted.

Catastrophe bond issuance tends to rise in the early part of the hurricane season, experts also noted. Firming reinsurance rates along with a new reluctance on secondary carriers to take on too much exposure after last year's meltdown-driven surplus depletion have been seen as some of the main factors.

As for sidecars, the $60 million financial vehicle sponsored by Renaissance Re for Florida risk appears to be the only game in town at the moment.

Max's Becker agreed that sidecar formation has been relatively small potatoes this year. "Many of those major suppliers of capital such as hedge funds have been badly damaged themselves," he said.

Any serious influx of new capital, should it take place, will gravitate toward existing players, rather than startups. "The liquidity trap of the 2005 startups is still a strong memory," Becker said.

Charman warned the reinsurance industry still remains at the lowest point of a pretty aggressive pricing cycle. When you couple that with asset-side capital depletion, one can expect some diminished earnings.

"So I do think that this is a year when we don't bet the bank," he said. For reinsurers, liquidity is now king.

"Most management teams in the sector are placing significant emphasis on maintaining plenty of liquidity and keeping a conservative financial position," said Carvalho.

Everest Re, Partner Re and XL are among the carriers that have chosen to perform cash tender offers on some of their debt, taking advantage of discounted pricing on these securities, she said.

Last year's numbers told a tale of greater-than-expected catastrophe losses along with those man-made depletions stemming from the financial crisis.

According to figures provided by the Reinsurance Association of America from its survey of 19 U.S. property/casualty reinsurers, while net premiums rose by $1.2 billion to $23.9 billion for 2008, the combined ratio rose 7 points to 101.8 percent.

Policyholder surplus, meanwhile, declined to $64.4 billion from $75.9 billion in 2007.

The first-quarter financial results for 2009 showed some improvement, according to Carvalho, with strong underwriting performances and modest investment losses. She noted that industry reserve releases stemming from the blockbuster profits of the 2006 and 2007 seasons masked some underlying weaknesses.

Nonetheless, she maintained an upbeat assessment, asserting that the appetite for reinsuers' wares will see an increase in part due to a new reluctance on the part of primary insurers to retain more risk, or rely on such alternatives methods as sidecar formation.

And then there's Florida ? always Florida.

According to figures provided by Aon Benfield, June 1 renewals produced Florida catastrophe price increases of between 10 percent and 15 percent, at the mid to lower level of the hikes expected.

Among the reasons cited were the projections by the Florida Hurricane Catastrophe Fund that an improving bond market would facilitate bonding capacity of up to $20 billion.

Earlier estimates had the projections at half that figure, and the decision by legislators to reduce the temporary increase in coverage limits by $2 billion sparked new confidence in the state fund in general.

Insurer net demand for Florida catastrophe coverage from reinsurers is relatively flat. Several primary companies would like more coverage if their original rates covered the cost. "Some companies increased their net risk by purchasing less capacity, increasing retentions, or not as comprehensively covering their potential reinstatement premium exposure," the authors of the Aon Benfield report wrote.

Meanwhile, the decision by the state-sponsored insurer of last resort, Citizens Property Insurance Corp., not to renew nearly $500 million in secondary coverage opened up some capacity.

In May, Gov. Charlie Crist signed into law legislation lifting the freeze on Citizens rates allowing for a 10 percent hike for the first year and then increases until the rates are deemed actuarially sound. "This easing of previous legislated freeze is an important step to increase the viability of the state-run program that competes with private insurers," the Aon Benfield authors said.

Challenges, of course, remain. They always do. Limited access to capital that reduces companies' financial flexibility and mergers-and-acquisitions opportunities are but the most serious ones.

A DEARTH OF M&A

The only reinsurance transactions of note so far this year were the Partner Re-Paris Re deal, and the more thorny courtship triangle among Max Capital, Validus Holdings and IPC Re.

Speaking a couple of weeks before IPC Re's board scuttled the proposed merger with Max Capital, and almost portending the event, Becker said the only deals possible today involved all stock transactions, what with most carriers coping with cash shortages stemming from meltdown-driven surplus depletions and less that stellar underwriting profits from pricing that has yet to achieve a healthy level.

"While quite simple on paper, they are quite complex because you have an abundance of business mix, control and other such issues related to the transactions," said Becker.

In early July, IPC announced that it had finally agreed to be taken over by Validus, after entertaining other offers from interested parties throughout the month of June.

The Validus deal is considered a "takeunder," valuing IPC at less than book value (albeit at a small premium to market value). Such transactions are rare, generally the product of straitened economic circumstances and IPC has fallen for less than its auditors think it is worth.

Carvalho said that S&P revised its outlook for Validus to positive for the expansion of programs and market opportunities the acquisition will facilitate. But she expressed concern about the relatively new company's appetite for expansion, noting the IPC deal is the second such transaction after its acquisition of the Lloyd's syndicate Talbot Underwriting Holdings in July of 2007

Becker, the head of the eventual spurned suitor in the IPC takeover, said before the Validus-IPC deal was announced, that any deal must properly reward shareholders for the value they would bring.

In addition, he said, the company would reduce its share in alternative investments by up to 7 percent by the end of the year to avoid a repeat of the dismal numbers posted in 2008 as the financial crisis took its toll.

The only real consolidation on the minds of reinsurance executives centered on the 2008 acquisition of Benfield by Aon, which made the new entity the dominant player in the arena with close to a 50 percent marketshare.

Charman said he feared the renowned Benfield modeling capability might get lost in the deal. "So I think that with two into one there has been a great loss of momentum and expertise."

Becker said the Benfield entrepreneurial spirit would not necessarily disappear in the blended organization. "The brokerage industry, whether it is on the retail side or the reinsurance side, has reinvented itself several times in the past two or three decades. I don't think we have seen the last chapter of this," he said.

While the costs of operating a brokerage concern have risen over the past few years, they do not constitute an insurmountable barrier to entry into the fields.

"So I suspect you will see some additional names on the horizon in the next couple of years," he said.

Charman countered that the costs of operating on the kind of global level of the Big Re 3 (with Guy Carpenter and Willis Re) will more than likely maintain the exclusivity of the group.

Rolf Tolle, Lloyd's franchise performance director, said that Benfield had been probably the most objective of the former four large players because it did not have a strong primary insurance operation, but in the end that might have spelled its doom as an individual entity.

As for more M&A activity, Charman said that, while management may be all right with the status quo, investors are starting to chomp at the bit because "there are clearly businesses out there on the peripheral that wish to establish themselves as a major force within the industry."

Charman and Tolle somewhat disagreed when it came to the virtue of size, with the former asserting that the larger the enterprise the more resources that avail themselves to large global clients.

"We are pretty complicated businesses operating in different product lines," he said.

Tolle said he did not see size necessarily equal with capabilities. Charman insisted he would be happy with 10 rather than say two dozen secondary carriers. "But you would not be happy with just three?" asked Tolle.

"No, certainly not," said Charman, who then added, "unless I was one of them."

Charman and Becker agreed that carriers housing primary and secondary insurance operations are the wave of the future.

"Our markets don't move in lockstep, and the ability to write insurance or reinsurance if you truly have the discipline to move your capital as the opportunities present themselves can be an advantage," Becker said.

Reinsurance's claim to be one of the least scathed sectors from the '08 meltdown may seem slight solace in the coming years as the industry continues to face the fallout from the great event.

While underwriting profits will most likely rise with firming pricing and some credit facilities return to normal, the approval of the final arbiter, Wall Street, will always to be just out of reach

Executives such as Charman will still look to the ultimate scorecard, the share price, with wistful longings and wonder why investors don't see the value they see.

"I think it is a strategic industry," he said. "And you are going to see that more and more over the next two to three years, especially with all of these capital constraints."

(This is the lead story from our 2009 Reinsurance Power Broker^TM package. Click on the following link to access the profiles of this year's Reinsurance Power Broker^TM winners.)

August 1, 2009

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