By JACK ROBERTS, editor in chief of Risk & Insurance®
There is something oddly appropriate about hurricane statistics, catastrophes and the annual Les Rendez-Vous de Septembre meeting of reinsurance buyers and sellers in Monte Carlo all occurring during the first few weeks of September. According to the Atlantic Oceanographic Meteorological Laboratory, the peak of the hurricane season is early to mid-September.
Last year's reinsurance meeting, like the hurricane season, was relatively quiet in a meteorological sense. Hurricane Katrina made landfall in 2005, just days before the reinsurance meetings began and visions of the New Orleans chaos dominated the meetings. Probably the biggest nonhurricane catastrophe in modern history happened during the Rendez-Vous in 2001--the bombing of the World Trade Center. Last year's tsunami was the implosion of the financial markets and the federal bailout of AIG, occurring nearly simultaneously with the Rendez-Vous. But even with that financial markets catastrophe, the reinsurance meetings were upbeat.
As the meetings begin this year, the reinsurance industry remains cautious, if not wary, about its future. What's next? Maybe we should expect the big one on the West Coast during early September.
Reinsurance, despite the uncorrelated catastrophic risk of the Monte Carlo Rendez-Vous meetings, remains something of a gamble. No catastrophes and it can be like hitting a number on the roulette wheel. The trick for an insurer is to try and get the odds to fall a bit more in your favor, perhaps helped by increasing prices or preparing for the probable maximum loss in a given year.
Loss costs, with a couple of significant hurricanes and other catastrophes, increased last year just as investment returns tanked in the wake of the hit to the financial markets, which pushed more than one reinsurer into the red. Successful reinsurers, along with all the ratings agencies, see enterprise risk management as essential to future success. In this market, just like in gaming, it can be tough to be a winner.
With these factors facing reinsurers, Mitch Blaser, president of Ironshore Bermuda, remarked that "risk management, particularly enterprise risk management, has to be part of an insurer's DNA. And here in Bermuda that's been part of our history almost from the founding of our company." Today, the same is true of almost every important reinsurer.
That means reinsurers, to succeed, must focus on strong underwriting and avoid the tendency to cut price during a soft market. That's difficult right now as AIG clearly has become more aggressive in the wake of scores of competitors looking to take business away from the market-leader.
But in the reinsurance markets right now, it's clear that reinsurance prices are firming, if not increasing, possibly foreshadowing at least the moderating of the current soft market. Current capacity remains adequate, according to reinsurance broker Guy Carpenter's analysis of July 1 renewals. Pressure to increase price remains, though it's not a return to the hard market.
On a year-over-year basis on national programs, Carpenter reports that prices are up about 15 percent. The capital crunch earlier in the year has abated, increasing capacity to a level that meets current demand.
Aon Benfield, in its July renewal report, also saw prices increasing by about 10 percent to 15 percent with July renewals getting placed earlier in June than in the past because of the anticipated continued hardening of the markets.
Meanwhile, industry executives point to a series of trends that may be coalescing just in time for Monte Carlo. Change and uncertainty envelopes a reinsurance business focused on issues of financial strategy and financial viability; supply, demand and pricing; competition; mergers and acquisitions (among both reinsurers and intermediaries); depressing worldwide economic conditions; unknown catastrophe events; an increasingly changing and challenging regulatory environment; upheaval at the ratings agencies; and ongoing questions about capital. It's an uneasy time to be in the reinsurance business.
CAPITAL AND MERGERS/ACQUISITIONS
Jim Brice, the recently retired CEO of IPC Holdings, with more than 40 years in the business, seemed a bit tired after the battle over the merger/acquisition of IPC with Max Capital just before his last board meeting as CEO. When stockholders turned down that deal, Validus, another Bermuda reinsurer, won out in an auction that followed the rejection of the Max Capital deal by IPC shareholders.
That scenario may play out again at another reinsurer, Brice said, because Bermuda reinsurers will have a hard time competing in the market without at least $1 billion in capital. And with relatively weak investment market conditions, especially for smaller publicly-traded reinsurers, opportunistic buyers may be able to acquire capital at a discount through an acquisition.
Kenneth LeStrange, CEO of Endurance Specialty Holdings, characterized the Bermuda reinsurance market as quite healthy, but he acknowledged that just a few months ago, the financial markets were closed to Bermuda companies and others seeking to raise capital. A number of investors, including hedge funds and private equity companies, remain on the sidelines possibly until the investment environment improves. But there is a question of whether this class of investors, which financed the creation of more than a dozen reinsurance companies in 2005 almost overnight, will ever return.
Thus, there is pressure on reinsurers to manage their risk and portfolios in light of capital restraints. "Just look at the impact of (hurricanes) Ike and Gustav last year. A good deal of capital has been withdrawn from the market," LeStrange said. He wouldn't be surprised "to see some additional mergers and acquisitions in the next 18 to 24 months driven by specific company circumstances."
And LeStrange agrees with Brice that "you need at least a billion in capital to be credible in the marketplace today." Endurance reported $2.5 billion in shareholders' equity as of June 30, 2009.
Blaser, of Ironshore Bermuda, which just raised $300 million in new capital to support its aggressive expansion effort, said the pressure is to have "the scale and ratings to attract business," adding that the capital issues remain in the forefront. "You have to make sure you have a clean balance sheet and you don't need to reload your capital in the wake of a major catastrophic event."
Meanwhile, Ironshore plans to grow its business with new capital and other alternative options: for example, it created a joint venture with CV Starr to form Iron Starr Excess Agency which plans to enter the competitive excess casualty cat markets.
Earlier this year, XL Capital boosted its capacity in the directors and officers space, long a strength of XL, in a deal with Berkshire Hathaway to expand its ability to underwrite Side A coverage. XL had been hard hit with losses related to the mortgage-backed security markets.
A big unknown in the marketplace are the potential substantial changes in the U.S. tax treatment of foreign domiciles for reinsurance companies, captives and other offshore investments. Legislation was reintroduced this summer and a coalition of 13 U.S.--based insurance and reinsurance firms are lobbying for its passage, arguing that foreign-domiciled insurance companies have an unfair economic advantage over their U.S.-based competitors.
The impact of these changes is difficult to predict even if they are passed, but Bermuda reinsurers have organized to oppose the legislation. That group commissioned a study of the possible changes under the legislation and the economic impact upon Bermuda.
The conclusion: this could reduce the ability of property/casualty insurers to manage their own risk and potentially reduce capacity in high-risk lines. Certain lines of insurance in certain key states would probably increase in price because of the changes in the tax laws, the study said. There is no guarantee of a net increase in tax revenues for the U.S. government because of the changes.
Meanwhile, various international regulatory agencies have been increasing scrutiny of international domiciles and despite the initial identification of some regulatory shortcomings in Bermuda, the Bermuda regulators have now emerged with a strong international ranking. Bermuda is among the leaders in the international regulatory reform movement.
While the markets may be challenging for the reinsurers, the reinsurance brokerage community will look significantly different at the Rendezvous this year. Gone will be the sleek Benfield cars that once sat parked in front of the Hotel de Paris across from the Casino. Instead of Benfield, the new mega-broker, is Aon Benfield, the result of the merger of the number one and number four reinsurance brokers. The former Aon Re obviously benefits from its greater size and position in the marketplace and a number of professionals pointed out that the addition of the Benfield analytical team adds important resources to the new company.
Integration of the two firms may be an overhanging factor, however. Said one chief underwriter at a Bermuda reinsurer (and his comments were echoed by others), "the question is whether one plus one will equal two. Right now it's more like one and a half."
Surprisingly, many reinsurance buyers agree and reinsurer underwriters commented that this change in competition has given Guy Carpenter something of an opportunity. With Carpenter's leadership change last year, the number two broker has become much more aggressive. "They are hungry," said one reinsurer "coming at us much more aggressively than they had been known for in the past."
A top reinsurer at a company that is aggressively increasing its penetration of the U.S. specialty markets wondered aloud whether the Aon Benfield merger will benefit from Benfield's team culture and overcome the independence of many of the producers at the old Aon Re.
THE U.S. MARKETS
Another major change among both reinsurers and insurers is the increasing amount of competition in the U.S. market. Allied World, with its acquisition of Darwin Professional Underwriters in late 2007, is in the midst of a big effort to expand in the U.S. in a number of specialty markets. Strategically, these kinds of actions often represent a diversification strategy for a number of Bermuda companies to their existing reinsurance business.
Allied's U.S. operations are led by Gordon Knight, a former AIG executive. Knight said that in this market, "there has been some chaos and dislocation because of the events of the past year. That's a great opportunity for us." The Darwin acquisition, for example, makes Allied a major player in the healthcare markets, an attractive specialty play.
Perhaps the most envied acquisition this year was the acquisition from AIG of the Hartford Steam Boiler company by Munich Re, positioning its U.S. operations--Munich American Re--for further expansion. Munich Re was able to pick up Hartford at a rock bottom price. And last year Endurance Specialty made a significant acquisition of an agriculture insurer well positioned in the U.S. market.
Talent remains an important factor, especially as long-time reinsurance executives retire. Ironshore, especially with the moves of Kevin Kelley and Shaun Kelly to join Ironshore, is competing to increase its share of U.S.-based business. Scores of former AIG executives now work at Ironshore--including Kelley who was the former CEO of the biggest excess surplus carrier in the world, Lexington Insurance Co., which is owned by AIG. Among the most recent former AIG executives at Ironshore, for example, is Geoff Smith who was brought on to head up the joint venture with CV Starr.
Luckily, in the hurricane prediction business, the forecasts for the balance of the year look like it will be quiet. But for those with a penchant for the long shot bet, one reinsurer pointed out that was the same story as the year Hurricane Andrew hit. In a few weeks we'll know whether 2009 will be different.
September 1, 2009
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