1 March 2011 Insurance

Down but not out

The 2011 January renewals season proved to be a disappointing start to the year for the reinsurance industry, with brokers reporting a continued softening of between 5 to 10 percent across the majority of lines.

There had been hope that 2011 would herald a turn in the market. Although the industry absorbed losses from some big events such as Windstorm Xynthia, the Deepwater Horizon oil rig loss and the Chile earthquake in 2010, the second half of the year had been relatively uneventful, with low insured catastrophe losses.

These subdued losses combined with unrealised investment gains led to record levels of capital in the industry, according to Guy Carpenter’s report Points of Inflection - Positioning for Change in a Challenging Market. This, in turn, drove reinsurance pricing lower at the renewals.

The report also found other reasons why the industry is finding it tough. “Given low valuations, low yields, macroeconomic instability, inflationary pressures and lower pricing, it is not unreasonable to argue that the current operating environment is among the most challenging in living memory,” the report said.

Others have also highlighted the abundance of capacity in the market. James Geffen, head of reinsurance at Miller, cites this as “the main pressure on rates”. While he also observes that “the decreases have slowed up”, Geffen admits that this is not the same as “saying that there is a proper correction in the marketplace”.

Additionally, a report by Aon Benfield, Partnership Renewed, found that “the January 2011 renewals softened at the high end of the rate of change”, which they had predicted in their Fall 2010 Reinsurance Market Outlook.

In another report by Willis Re, called Keep Calm and Carry On, the broker pointed to further frustration for reinsurers, in that “despite predictions, the pricing gap in most classes between reinsurance and primary business shows no signs of narrowing”, resulting in primary carriers “purchasing less, particularly in casualty lines and reinsurers seeing reducing premium volumes”.

On the up

But while the January renewals proved disappointing, there appears to be a feeling within the reinsurance community that things could have been a lot worse. The Willis report notes that “despite the continued softening and the worst ever first quarter for natural peril losses on record, the global reinsurance market has emerged from 2010 relatively unscathed, aided by recovering investment positions and continuing strong reserve releases”.

Also whilst the majority of lines have remained either flat or down, there were a few lines that did show positive movement, including marine & energy, and business in specific countries hit by catastrophes last year such as Chile, Australia and New Zealand.

In regards to the marine & energy sector, Aon Benfield’s report found that “the disparity between client expectation and reinsurers has increased”, and although reinsurers have been measured in their reaction to retention levels,“pricing has been revised to cater for previously unexpected risk accumulations”.

Guy Carpenter’s report noted that pricing in the marine & energy sector was a mixed bag, with international hull, war and liability rates remaining flat, and cargo down. However, in regards to energy: “The effect of the Deepwater Horizon loss was to drive prices for energy business significantly, up 15 percent to 35 percent, though these increases were not as great as had been predicted by many commentators prior to the renewal season.”

Following the Deepwater Horizon loss, Willis Re’s report also found that the offshore energy market is seeing large primary rate increases, which are feeding through to unchanged pro rata commissions and large increases in XL rates even of loss-free programmes.

In regards to Chile, whilst reinsurance rates remained flat for programmes that had not experienced loss in Latin America, the Guy Carpenter report found that those affected by the Chile earthquake sustained rate on line increases of 40 to 60 percent, depending on specific loss experiences.

The report also noted that “per risk working layer programmes were flat to up 10 percent if there was loss activity, and high-risk excess programmes were flat year over year”.

With regards to Australia and New Zealand, the Guy Carpenter report found that reinsurance rates trended up slightly for loss-free programmes, with those affected by losses sustaining higher increases. Few programmes avoided losses given the busy catastrophe year the region has experienced.

Despite this loss activity, the Aon Benfield report found that “capacity remains abundant across a range of classes of reinsurance” and that “pricing in all classes is very much loss experience driven and pressure on retentions remains isolated only to specific cases”.

However, some believe that it is too early to call. “In New Zealand, where the numbers appear to be getting bigger, the renewal season from a reinsurance point of view does not give us the full picture,” says Geffen. “We need to watch the numbers develop before judging the reinsurance market response.”

Predicting the future

Most reinsurers are now asking about when the market is likely to turn. However, it appears that they might have a long wait on their hands.

“I can’t see anything happening for 18 months,” says Geffen. “There is nothing on the horizon that will have a significant impact in the next 12 months. Recent underwriter results show no obvious reason for change.”

Aon Benfield’s report also confirms this gloomy outlook, predicting that at the April, June and July 2011 renewals, the market should expect further “softening at a pace similar to what we observed during the January 2011 renewals”.

In terms of what it would take to harden the market, most brokers seem to agree that a $50 billion loss event would do the trick—although the chances of this occurring soon are naturally slim.

However, whilst the Guy Carpenter report acknowledges that soft market conditions show no immediate signs of reversing, it also points to a possible light at the end of the tunnel. According to the report, there are “an increasing number of latent factors which—alone or in combination—could at some point precipitate a meaningful change in the market’s direction”. The report also suggests that “depending on loss experience, these factors could begin to coalesce around renewals later in the year”.

These factors could of course include the hotly anticipated Solvency II regulations—and the potential ramifications that they could have for reinsurers.

“Solvency II may require some to buy more, and depending on who is capable of providing this capacity, could influence some movement, but probably not significantly,” says Geffen.

This point is echoed in Aon Benfield’s report, which predicts an increased demand for reinsurance, “driven by the need to seek capital relief under the more onerous regulatory requirements”. The report also foresees a greater demand for aggregate covers and more specialised reinsurance products “in order to reduce earnings volatility” and that this trend will continue as companies aim to optimise the use of their capital under Solvency II.

One other potential catalyst for a change in the market is highlighted by Guy Carpenter’s report, which points out that prior to the last hard market, underwriting cash flow turned negative. This is significant because “underwriting cash flow has turned at least marginally negative in 2008 and 2009”, the report said.

Whilst there are indications that the market could turn at some point, it seems likely that reinsurers will have to either wait for over a year for a number of factors to coalesce—or for a major loss event to occur—before rates begin to harden.

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