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STEVE TUCKEY, a long-time financial journalist who lives in New Jersey.

The reinsurance industry started 2011 with fears of another soft market as prices drifted down by nearly double-digit percentages. Then an Australian cyclone, earthquakes in New Zealand and Japan, and flooding and a string of tornadoes in the United States led to one of the most costly first-quarter insured loss figures on record and some reevaluations of pricing.

"The effect cat losses had on the sector's capital position mid-year, combined with the fact that we still have the hurricane season ahead of us, led to some firming in property catastrophe lines with the caveat that the change was dependent on the model version used to compare year-on-year," said David Flandro, who heads Guy Carpenter's global business intelligence team.

Flandro said prices rose an average of between 5 and 10 percent, using last year's RMS model version as a stable baseline to calculate the amount of risk in both this year's and last year's programs. "And within this there is a wide range of outcomes for individual programs," he said.

The Guy Carpenter team estimated in June that total dedicated reinsurance capital stood between $165 billion and $175 billion, while the first-quarter insured losses halved the excess capital figure to $10 billion.

Standard & Poor's said in its April reinsurance sector review that estimates of first-quarter insured losses range from $28 billion to $45 billion.

In a survey of 19 U.S. property casualty reinsurers, the Reinsurance Association of America reported the average combined ratio for the group rose more than 27 points for the first quarter of this year, to 129.3, compared with the same period in 2010. Net written premiums also rose to $7.1 billion for the quarter, compared with $6.4 billion last year.

Costas Miranthis, president and chief executive officer of Partner Re, told a recent Standard and Poor's forum that June 1 price increases crept into the low double-digit area and he estimated that the spike in Japan earthquake cover rose between 40 percent and 60 percent.

"Clearly the momentum is with us, particularly in light of the fact that model changes have yet to be factored in," he said.

Moody's senior credit officer James Eck said in early June that June-July pricing will depend on the stance taken by the European reinsurers. Flat pricing could result from the fact that the first-quarter losses merely replaced share buybacks as use of capital. Pricing could also be influenced by the potential obligation of reinsurers to deploy capital, since they have already spent money on retrocessional protection for the rest of the year.

"However, it is also important to note that two of the largest reinsured earthquake zones in the world have seen major losses in a two-month span, which is likely to cause underwriters to push for higher rates," Eck said.

Standard & Poor's analyst Laline Carvalho said there are plenty of indications that firming pricing will last into the 2012 renewal season. And she said casualty remains the problem child for reinsurers looking to make an underwriting dollar. "Casualty pricing has been declining for several years and it has gotten to the point that many reinsurers are not even attempting to write that business," she said.

Among sectors ranging from the heavily regulated workers' compensation business, to directors' and officers' and medical malpractice coverages, Carvalho said it remains difficult to pinpoint one factor in the steady decline. "But with accident-year loss ratios creeping up, and investment income that could offset some of this under pressure from low-interest rates, the sectors can no longer rely on prior-year reserve releases, which we believe are not sustainable," she said.

Miranthis said any significant upward price movement is at least two years away, and would take some serious reserve charges to get the ball rolling. "But at least there is no downward pressure," he said.

Flandro said inflation has emerged as a significant concern for casualty underwriters whose liabilities tend to run for longer periods. "And we are just not talking about macroeconomic inflation, which is significant, but claims inflation, commodity inflation, medical inflation," he said.

A recent Bank of England report putting the United Kingdom inflation figure at 4.5 percent for the fourth straight month has aroused concern, even though sharp spikes in the price of gasoline sometimes produce momentary distortions. "What we worry about is that inflation might surprise everyone, and our clients are starting to worry about that in a little different way than they have for a while," Flandro said.

But that will not necessarily lead to a long-awaited market hardening, since companies could tend to defer insurance purchases like they did during the last period of high premium pricing during the President Carter years in anticipation that such inflation will go down, Flandro added.

"It can have pretty malign effects in the short term, if it happens," he said.

But there have been other occurrences and actions that reinsurers have taken, which could offset the ill effects of inflation.

A.M. Best analyst Robert DeRose said favorable conditions last year led reinsurers to more actively manage their debt with several new issuances to take advantage of low interest rates. Such repurchases represented about 60 percent of overall net income, he said.

Carvalho said the first-quarter losses have forced most reinsurers to reevaluate their capital management strategies, resulting in a reduction of their share buy-back programs. "However we don't believe that these recent disasters will trigger a wholesale demand for a capital injection, either from existing players or new market entrants," she said.

In yet another event that could have an effect on reinsurers, in February, Risk Management Solutions revised its hurricane risk model, resulting in an expected increase in loss estimates for all return periods. The move prompted Standard & Poor's to put 17 natural peril catastrophe bonds on credit watch with negative implications. Carvalho said that such model changes normally do not spark rating changes but that these were serious enough to allow for that possibility. Florida experienced the least change and Texas the most serious in terms of more increased probable maximum property loss estimates.

But that did not slow down the catastrophe bond market, which saw a first-quarter record $1 billion of risk capital issuance of new bonds this year.

While the model change effect on pricing for the short term remains uncertain, DeRose said it probably foreshadows changes to come in quake models based on experiences gained in Japan. "Some seismologists never expected a 9.0 quake in Tohoku, Japan, based on the specifics of the tectonic plates, and Japan has some of the world's best seismic data," he said.

All eyes for the June 1 renewal season focused on Florida, where recent legislative changes passed under the eye of a more industry-friendly governor, Republican Rick Scott, gave insurers more leeway in achieving rate increases. Fitch Ratings analyst Greg Dickerson called the legislation "significant progress," noting how it contrasted with the attitude of the previous governor, Charlie Crist, who in general promoted the expansion of the state insurer of last resort, Citizens Property Insurance Corp., and the Hurricane Catastrophe Fund.

Still, Dickerson noted that Florida's new property insurance law falls far short of industry expectations in that it doesn't prevent Citizens from competing with the private market. He feels that its pre-eminent position as a property insurer in coastal areas is an indication of the unwillingness of private carriers to provide the capacity due to unfavorable economic conditions and the industry's perception that Citizens has an unfair advantage.

Forecasters are predicting above normal hurricane activity for the Atlantic Basin and Gulf Coast, although those predictions were tempered from the initial forecasts.

So the question remains as always: How much capital loss will it take for the market to make a dramatic and relatively lasting turn? But with so many factors, including overall economic conditions, reserve development trends and interest-rate movement in play, reinsurers will just have to look to another sage of history, Paul Volcker, who when asked for his predictions on interest rates replied, "they will fluctuate."

August 1, 2011

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