By STEVE TUCKEY, who has written on insurance issues for a decade for several national media outlets
Editor's note: This feature article is our cover story for the 2010 Reinsurance Power BrokerŪ
package. Please view this year's 2010 Reinsurance Power BrokerŪ winners here.
For reinsurers in 2010, the hard rain that Bob Dylan first sang about in 1962 could take the literal form of a record hurricane season whose losses will deplete capital in the short run, yet at the same time could help shore up pricing in the future to produce more profitable years.
Or the hard rain could take the metaphorical variety of continued price erosion in both property and casualty lines, which will challenge reinsurance management teams to come up with more efficient ways of deploying capital as primary insurers attempt to squeeze every last premium dollar they can knowing they have the upper hand.
The first three months of this year bode ill for the rest of 2010 as catastrophes drove the combined ratio up 7 percentage points to 102.2 percent compared with the year-ago period, according to a survey of 19 reinsurers conducted by the Reinsurance Association of America.
The $16 billion in losses, including about $8 billion for the Chile earthquake, represent a record for this period, and forecasters in June were predicting a hurricane season that could approach the 2005 season's record losses.
For 2009, the combined ratio arrow faced the opposite direction as a relatively light catastrophe year produced a 93.5 percent figure compared to 101.8 percent for the previous year.
In addition, large investment gains, both realized and unrealized, and favorable loss reserve development were key to strong performances by U.S. and Bermuda reinsurers, according to a Standard & Poor's report.
It was the good news from 2009 that, ironically, was creating difficulties for reinsurers this year seeking profitable pricing, said George Venuto, executive vice president for Willis Reinsurance.
"Trying to please primary casualty insurers is probably the most difficult thing to do right now," he told a recent Casualty Actuarial Society seminar in New York. "On the property side, we continue to see rate pressure. The model changes have created a visible downward pressure on pricing. It is not the best pricing environment on the insurance and reinsurance side."
Standard & Poor's director Damien Magarelli said that a recent increase in severity combined with frequency, now flat compared to its recent declining state, point in the end to an increase in loss cost trends that will eventually erode profits.
"If there is acceleration in loss cost trends, then you may see a dramatic increase in losses and reduced earnings," he said. A positive trend this year remains the increasing number of stakeholders who are keeping an eye on pricing compared to the prior decade.
"It is not just actuaries," Venuto said. "Now everyone gives you a price monitor. We really see where the trends have been. Terms and conditions have held and that was the monster under the bed in the late 1990s. We will come out of this soft market better than the last one mainly because actuaries are more involved than they were in the past."
Another difference between then and now is appetite for risk, Magarelli said. "There's more discipline now. Better tools. Another fundamental change is that reinsurance companies are restrictive in terms of capacity. We're still going to have cycles, but we may not have as many peaks and valley as we have had in the past."
Magarelli said that U.S. and Bermuda reinsurers face deteriorating accident-year performances this year as property-casualty prices continue to erode.
"Most global reinsurance market participants seemed to agree that pricing for both U.S. property and catastrophe risks fell by about 5 percent to 10 percent during the Jan. 1 renewal season," he said.
The analyst also said that casualty reinsurance pricing has declined up to 10 percent in recent months, which "may appear as a relief compared with the potential for more substantial rate decreases." With casualty rates under pressure at the primary and secondary level for six years, the quality of business has seen declines.
Just how much the decline in casualty rates has stemmed from positive loss cost trends remains a topic of debate among experts, Magarelli said. No matter. There exists a consensus that the trend remains unsustainable. Coupled with a new, more conservative investment philosophy since the events of 2008 financial meltdown, there is no longer the cushion of investment returns to make up for pricing shortfalls.
"With most areas in casualty reinsurance still fairly competitive, any further rate declines in this segment could lead it to produce negative operating returns," Magarelli also said.
The June 1 start of hurricane season provided little relief for property rates.
Florida renewals declined 10 percent to 12 percent, according to report from the New York City-based reinsurance broker, Guy Carpenter & Co.
Lara Mowry, global head of property specialty for Guy Carpenter, said the downward pricing trend reflected a "return of capital to the marketplace, balancing a scarcity of capital we witnessed last year."
Florida regulators helped increase that capacity, too, by relaxing collateral requirements for alien reinsurers, including XL Re and Hannover Re that based the new collateral figure on a sliding scale with none required for AAA-rated reinsurers, and collateral discounts for other well-rated insurers.
Moody's said the new collateral flexibility was good for Florida insureds while reducing the cost of doing business for foreign reinsurers, but could prove worrisome to primary company reinsurance buyers as well as to domestic reinsurers who now face new competitive pressures.
For more than a decade, alien reinsurers have sought redress through the National Association of Insurance Commissioners, who in the past several years have attempted to come up with some formula to achieve it.
But regulators have always faced vigorous lobbying from domestic carriers, and so alien companies may gain some relief on a state-by-state basis only.
The world's largest reinsurance broker, Aon Benfield, looked at the same Florida market but took a less sanguine view. In a report issued earlier this summer, Aon Benfield said the state lawmakers offered little hope for private insurers to achieve rate increases while competing with the state's property insurer of last resort, Citizens.
"Rate recovery has been especially challenging, and in some unfortunate cases has proven unsustainable, with several insurers insolvent or near insolvency," the report said.
The result has been a reinsurance market carefully selecting cedents most likely to survive a hurricane-free 2010, even as Demotech, the principal rating agency for residential insurers, articulated standards that called for more reinsurance for some questionable carriers. "The net effect of this backdrop was to continue the significant feeling of uncertainty about how or when the Florida residential market will make the transition to one that maintains the availability of insurance from private carriers for Florida residents," according to Demotech.
That uncertainty also drove reinsurance capacity from Florida to other markets with an expected price-depressing effect. And so, for reinsurers, the Florida market remained one of the few areas that became more rather than less risky in 2009 and in the first half of this year, the report concluded.
Eroding prices have also taken their toll on share prices to the point where 14 of the world's 23 largest publicly trade carriers are trading below book value, according to data compiled by Bloomberg.
The result has been an increasing number of carriers going to the bond market to purchase debt in order to buy shares to boost prices. In a research note earlier this summer, Moody's analyst Kevin Lee expressed concern that such bondholders could be "particularly vulnerable" in the event of a major catastrophe when reinsurers could face difficulty getting new capital to replenish storm-depleted coffers.
The announcement earlier this year of the Harbor Point-Max Capital merger could be a harbinger of things to come, Willis Re Chairman Peter Hearn said.
"Financial organizations that received government support over the last 18 months are starting to divest themselves of their insurance assets as part of the recovery process," he said. "With both the current modest valuations and continued difficulty of obtaining top line growth, the pace of M&A transactions is likely to pick up."
Speaking at the Standard & Poor's insurance conference in June, Partner Re President and CEO Patrick Thiele justified his firm's acquisition of Paris Re last year as the need to bulk up on premium as opposed to hoarding capital. He said that the larger and more diverse the premium block the less risk you are posing to your shareholders.
August 1, 2010
Copyright 2010© LRP Publications