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By Steve Tuckey

The stark contrast between the record-setting natural catastrophe losses of 2011 and the so far benign 2012 season has proved challenging for reinsurers, which are looking to adequately price risk in an environment replete with potential economic catastrophes; witness the volatility that is roiling Europe.

But no such class resulted this year for any number of reasons, including the fact that the lion's share of 2011 losses took place in the first half of the year and were accounted for in renewals in the spring and summer of that year.

Thus, the estimated mid to upper single digit price hikes seen in this year's June 1 renewals did not disappoint industry players as much they might have, since they came on the heels of double-digit price increases in the previous year.

The price moderation continued through the July 1 renewals, according to Lara Mowery, head of Global Property Specialty for Guy Carpenter & Co. with the activity marked by "disciplined underwriting and plentiful capacity."

First quarter net written premium rose to $7.7 billion from $7.1 billion in the comparable year-ago period while the combined ratio fell to 95.6 from 129.3, according to figures provided by the Reinsurance Association of America from a survey of 19 U.S. reinsurers.

Analysts said that improved enterprise risk management strategies employed in the wake of the record losses of 2005 were the primary reason that last year's losses fell short of being an existential threat to the industry, falling instead into the category of an earnings event.

David Cash, CEO of Endurance Specialty Holdings, said that primary insurance company buyers of reinsurance were in a better position this year when it came to reinsuring Florida risks. Big insurance companies were able to retain more risk and buy less reinsurance whereas in 2006 "they had to buy," he said.

David Priebe, Guy Carpenter & Co. vice chairman, said in 2012 reinsurers authorized increases in capacity where pricing globally seemed adequate. The variance in price increases in Florida among reinsurers was more muted compared to the 2011 renewal periods that followed the initial shock of the year's first-half losses, Priebe said.

Priebe said the variance stemmed from differing ways in which companies view risk as reflected in their use of models, both in-house and those purchased from outside vendors.

"Reinsurers are implementing more sophisticated approaches using custom risk measures, based on their own research and experience," he said.

That factor goes a long way toward explaining why RMS 11, released early last year and forecasting more severe catastrophe loss, particularly on the Texas Gulf Coast and in the Northeast, did not cause the spike in pricing that was initially predicted.

"What RMS 11 did, because it created such a divergence of potential outcomes between that and their previous version, reinforced the notion that insurers should not rely on just one model for their rating and portfolio management and that they had to take ownership of how they view risk for their company," Priebe said.

Moreover, the recent trend for primary companies to retain more risk has prompted reinsurers to "develop a more proactive capital management strategy through share repurchases and dividends vs. having to say 'I have to chase business,' " he said.

In addition, secondary companies are seeking more contingent capital through the use of retrocession sidecars as part of this strategy while both primary and secondary companies are increasing their use of alternative capital in general, including catastrophe bonds.

GC Securities reported a record $1.34 billion of risk capital was issued through eight catastrophe bond transactions in the first quarter of this year, exceeding last year's record $1.02 billion from the same time period.

For investors, said Standard & Poor's director Gary Martucci, the bonds represent handsome returns of between 6 percent and 17 percent correlated to the whims of Mother Nature as opposed to say, the political winds in Greece and Italy. "And the insurers get the diversity of risk with the collateralization they are looking for and long-term pricing that is locked in for two or three years," he said.

In Florida, the state-run Citizens Property Insurance Corp.'s record offloading of risk in 2012 will result in an increase of $175 million to the traditional reinsurance market, according to a report from Aon Benfield.

But Cash said the creation of a couple of single-risk reinsurers created in response to that action, along with a number of sidecars aimed at the property catastrophe retrocessional market, mitigated any market hardening that might have resulted.

Albert Benchimol, CEO of Axis Capital Holding Ltd. welcomed alternative market capital in any such capital deficiency. "They have no problem exiting the market when the pricing gets lower," he said. "Therefore, they will also cut the bottom of the pricing."

Cash took aim at what he termed the "morbid obsession" with Florida since it is a risk easily understood, saying it comprised only about 3 percent of his company's book of business.

And the 2011 catastrophe losses in Thailand, New Zealand and Japan along with the U.S. Midwest underscored his opinion.

Whenever severe losses occur in relatively virgin territory, Cash said "the question you have to ask yourself is, 'Is your loss in proportion to the size of the event?' "

While the March 11, 2011, Japan earthquake produced losses within company expectations, Cash expressed disappointment with his company's Thailand losses.

"Those are losses I felt we should have had a better handle on. And that was the case where there was a very large concentration of industry risk, and those are hard ones for reinsurers to monitor as a lot of that risk had moved to Thailand from Japan."

Benchimol summed up the main lesson from 2011 by saying that all the sophisticated modeling in the world will not prevent the kind of surprises that send underwriters back to the drawing board. "No one knew a fault lied under Christchurch, and none of the models you could buy or develop assumed a 9.1 earthquake in Japan. And the last time we had the kind of floods we had in Thailand there were rice paddies there."

Fitch Ratings analyst Brian Schneider said that the reinsurance industry got something of a break in connection with Japan. State reinsurance programs covered about half of the $35 billion insured loss, while the primary sector absorbed a further share.

Favorable reserve development over the past several years has proved a boon to reinsurers' bottom lines, and forestalled the development of a hard market developing, analysts said. In June, Aon Benfield reported that U.S. redundant reserves, funds that the industry estimates will not be needed to pay claims, stood at $11.7 billion, compared with $22 billion the previous year. The agency predicts slightly lesser reserve releases for this year, and expects them to end in early summer next year at the current run-rate.

"The headwind against a broad market hardening from reserve releases continued in Q1 2012," said Stephen Mildenhall, chief executive officer of Aon Benfield Analytics in a statement. "However the forecast is for the winds to abate over the next four to six quarters, with the hard market years slowing, and the most recent accident years booked less conservatively."

A.M. Best senior financial analyst Greg Reisner said that favorable reserve development has helped prolonged the soft market. "While pricing for nonpeak zones has improved after the losses, even with the improvement, it will take years for insurers to earn back their underwriting losses," he said.

That favorable reserve development is virtually the only factor allowing reinsurer participation in the casualty business, given its pricing and low interest-rate environment. "It is still unknown as to how long the market will bump along at the bottom. The global reinsurers are awaiting the inevitable change, which is very much needed to generate sufficient returns to cover the cost of capital," Reisner said.

STEVE TUCKEY has written on insurance issues for a decade for several national media outlets. He can be reached at riskletters@lrp.com.

August 22, 2012

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