It's an interesting time for reinsurers as the market crests the wave down into the soft part of the cycle.Many experienced players are sitting tight, others are chasing pockets of opportunity in particular classes. So far most are resisting the obvious, but somewhat dangerous, temptation to cut prices in pursuit of market share.
Reinsurers are finding themselves squeezed between their primary clients, their own strong recent results and the much sharper decreases in prices seen in the direct and facultative markets--around 30 percent plus. So, the theme of January renewals was competition, with the season starting late and orders making it into the market at the very last minute and many firm orders being placed at well below the initial quotes.
Barring a major shock, most market participants are anticipating soft market conditions across the board for a number of years. The down cycle following Hurricane Andrew in 1992 lasted for six years, and a lengthy period without large losses will put further pressure on prices and possibly increase the temptation to chase market share.
The past 12 months saw another excellent year for reinsurers with a strong earnings stream strengthening balance sheets further. Contrary to some expectations, the appetite of the capital markets for reinsurance risk remains healthy, with the subprime crisis emphasizing the attraction of an uncorrelated risk class, and both investors and reinsurance buyers becoming more comfortable in this space. This abundance of capacity in the market and the fact that the claims picture looks relatively benign are key drivers of market behavior.
While reinsurers have been more willing to return surplus capital to shareholders, some $20 billion in 2007, there is certainly pressure from ratings agencies and regulators, as well as investors, to manage capital more efficiently. Nevertheless, prices are inevitably starting to slide. The trend varies in degree by class and location--but the overall movement is undoubtedly downward and unlikely to reverse any time soon.
Traditionally in a soft market underwriters are encouraged to look very carefully at what they write, and if in doubt say "No." However, there are different attitudes in different markets. In Bermuda for example, the U.S.-backed reinsurers still believe that there is good business out there and are actively looking for opportunities. A number of the U.K.-listed Bermudians are much more willing to walk away from risks if the price is not right, and some are fully expecting to have a quiet summer.
Part of this may be in response to the fact that the volatility in the stock and bond markets means that reinsurers cannot rely on the cushion of investment returns. While portfolios may not be in immediate danger, there is still substantial downside potential on the liability of the balance sheet and not inconsiderable ongoing uncertainty, with increasing talk not just of recession, but potentially depression--a term not used in anger outside medical circles since the 1930s.
After early signs that losses to the mainstream reinsurance market were not significant, the downgrades of the monoline players and the reported losses from major reinsurers such as XL Capital, reporting losses of $1.5 billion, and Swiss Re, $99 million, have changed the landscape substantially. Whether or not these will have an impact on 2007 results, and the outlook for the rest of 2008, remains to be seen.
2007 was another exceptionally light year for catastrophes in the reinsurance market. In terms of degree, there are a number of opinions in the market, but from our perspective we would describe property treaty rates as 'easing' rather than falling dramatically.
Falls of around 10 percent were not uncommon for traditional U.S. business, particularly where exposures had not increased or the portfolio has not changed. There've been some instances where decreases spiked to around 20 percent, but that has normally been triggered by the account moving to a competitor. The signs are that the June 1 renewals will see similar size declines.
In the property market it is difficult to see the overall downward trend being reversed, or even stabilized, without a major catastrophe, and many believe there would need to be increases in both frequency and severity to really make a substantial dent in the capital base of the market.
There are, however, some geographic pockets where specific activity in the primary market means that the demand for or supply of reinsurance is affected. For example, in territories which are prone to isolated storms--tornadoes or hail storms--seasonality appears to be shifting dramatically, and start and finish dates are extending or even disappearing. This means that insurers in these areas are finding prices remaining more robust than in many other areas of the country.
There are some interesting developments in the South. The state of Louisiana is actively encouraging the creation of new private insurance companies to offer cover in the home and motor markets. The creation of these new carriers obviously flows through to an increased demand for reinsurance, which is often at improved prices given the fact that they are start-ups.
The potential reduction of catastrophe cover being offered by the Florida Hurricane Catastrophe Fund from June 1 means that there could be some increased demand at the top of programs from the reinsurance market. However, aggregate limits will probably mean that reinsurers will be constrained in how much of this business they can do.
Driven by a desire to ensure that capital is working as productively as possible, rather than hand it back to shareholders, reinsurers are looking to employ capacity in new areas. This has meant an acceleration of the trend which has seen capacity move away from coastal areas toward the Midwest. Since the market is seeing new entrants, or at least an expansion of existing books of business, price competition in this area is becoming more aggressive.
As with property, 2007 was a benign year in terms of casualty losses. In addition to an abundance of capital, the increased focus on diversification is driving competition in this area. While there have been few new entrants, the Barbican syndicate at Lloyd's being a notable exception, the newer reinsurers, particularly in Bermuda, are increasingly involved. Casualty pricing therefore continued to decline steadily, a trend which started in the primary market around 2005, and many believe may be reaching dangerous territory in terms of pricing.
In the United States, primary pricing for workers' compensation declined in 2007 by just over 10 percent, following single-digit reductions in the two previous years. At the January renewals the reduction in reinsurance rates averaged around the same levels across working and catastrophe layers, and cedents have demonstrated a desire to increase their retentions, with most enacting moderate increases to reduce the overall cost of insurance.
In the medical malpractice arena, the last few years have been extremely profitable, and as with other areas of the casualty markets, ceding companies are retaining more risk and buying less reinsurance. All the major markets: the United States, London, Europe and Bermuda are seeing some softening of price, however discipline does seem to have been maintained at the year end renewals, with premiums typically declining by a mere 10 percent to 15 percent. Some of this may be due to uncertainty over future claims. There has been a dramatic reduction in the frequency of claims in this class, however the severity is very high and rising. The result is that there may be some underfunding in the excess layers combined with the threat of bad faith claims that may run into many millions of dollars.
For directors' and officers' reinsurance, rates were generally stable, but dependent on the profile and experience of the reinsurance portfolio. However, the key issue in this sector is the subprime issue?the rapid development which is making the market nervous and especially conservative regarding financial institution risks. The fourth quarter of 2007 saw a reversal of the declining trend in securities class action filings, with a large number of claims which are expected to have a negative result on certain D&O results.
Overall, this seems to be a time for reinsurers to sit tight, keep a watch on specific areas of opportunity and resist the temptation to chase market share at any price.
HUGO CRAWLEY is chairman of BMS Group.
May 1, 2008
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