Still some way off

As the reinsurance industry digests the recent April 1 Asian renewals and prepares for the US equivalent in June/July, the majority of players will hope that the recent series of catastrophes in Asia combined with ongoing political unrest in the Middle East will be enough for rates to begin hardening after what has been a long soft market.

They could be sorely disappointed. While most players report some evidence of hardening on property-catastrophe lines—especially those with exposure to Asia—these increases are not significant as yet and most other lines of business remain stubbornly flat.

According to reinsurance broker Guy Carpenter, the US property-catastrophe market is in transition. Its preliminary analysis of the market, completed in a report issued at the start of April, suggests that renewal pricing is roughly flat to up slightly—a positive change compared with the decrease of between 6 percent and 10 percent it reported in the January 1 renewals.

While this change has mostly been caused by recent natural catastrophic activity, the release of risk modelling company Risk Management Solutions’ (RMS) new US hurricane model has also caused some movement in the market. Early indications are that it could mean changes in results and this uncertainty made cedants hold their terms on rates.

Guy Carpenter says that the full implications for the June/July renewals remain to be seen. But it acknowledges that the events in Asia have depleted the industry’s capital and any further events would certainly test the industry’s capital base.

“While the actual impact that first quarter losses will have on dedicated reinsurance sector capital for the full year remains to be seen, many reinsurers’ 2011 natural catastrophe budgets have been exhausted, and a portion of the sector’s excess capital has been absorbed,” says David Flandro, global head of business intelligence, Guy Carpenter & Company.

“While any future significant losses in 2011 could put additional strain on reinsurers’ capital, the industry is well positioned to deal with this scenario, given our estimates that total dedicated reinsurance sector capital currently ranges between $160 and $180 billion.

“The implications for the June/July reinsurance renewals are unknown at this time. In the short term, we expect to see increased demand for reinsurance cover and share repurchases likely scaled back or suspended until a clearer picture emerges.”

Other brokers agree with Guy Carpenter. Towers Watson, in its review of rates at the April 1 renewal season, says that only yet another major event would trigger a hardening of rates in the June/July renewals to the extent that occurred in 2006 after Hurricane Katrina. Prices have been steadily falling ever since.

“Absent another event, we do not foresee the same level of price increases that we saw at the beginning of 2006,” says William Eyre, managing director of the reinsurance brokerage at Towers Watson. “The 2010- 2011 losses are widely believed to be more of a significant ‘earnings’ event rather than an impairment to capital.”

This sentiment is echoed by Willis Re, the reinsurance broking arm of Willis. The broker says in its April 1 renewals report that the Tohoku earthquake will not be the catalyst that will bring about a hard market. However, the total tally of first quarter devastation, including the Japan, Chile and New Zealand earthquakes and the Australian floods, has accelerated the likelihood of a market-wide turn should reinsurers be tested again this year.

Titled Shaken and Stirring, the Willis Re 1st View renewals report found that while there have been rate increases on natural catastrophe excess of loss of between 5 and 50 percent, the Tohoku and Christchurch earthquakes are not by themselves sufficient to drive up market-wide pricing.

To trigger a hard market, there needs to be an additional accelerant such as another major natural catastrophe loss, inflation, the reversal of back-year reserve releases or wider financial issues impacting investment income and balance sheet strength, the broker says.

Willis Re notes that of the total 2010 catastrophe losses—approximately $60 billion of insured losses to the global insurance industry in a 13-month period to March 2011—it is currently estimated that between $35 and $42 billion has been passed from primary insurers to reinsurers.

Reinsurers have been able to absorb these large losses due to their robust capital position—a product of excellent underwriting results in 2009 and strong investment performances for both 2009 and 2010. But Willis Re warns that while reinsurers’ financial strength may be largely unimpaired, their financial flexibility could be impacted, resulting in less M&A and reduced share buy-backs and other excess capital management techniques.

“Throughout the recent, significant global events, reinsurance responded to the needs of global and regional insurers as intended, with material volatility shifted to reinsurers from the balance sheets and income statements of global and regional insurers.”

The Willis Re report finds that the most immediate challenge for many reinsurers is that the losses suffered to date in 2011 have largely exhausted their annual catastrophe loss budgets. In response, reinsurers are trying to proactively manage their underwriting results for the remainder of 2011 by applying rate increases in areas of natural catastrophe loss activity and tightly controlling their capacity deployment.

“While the financial strength of the reinsurance industry remains remarkably intact in the wake of Tohoku, it can only withstand so many blows,” says Peter Hearn, chairman of Willis Re. “The reinsurance industry is on the cusp of change and a hard market may be only one more major event away.

It could be something as dramatic as a catastrophic hurricane during the upcoming North Atlantic and European winter windstorm seasons or something more systemic like creeping inflation, but whatever the cause, reinsurers have proven their resilience and are gearing up for a bumpy ride over the remaining months of 2011.”

But some brokers are more negative again, believing that, despite recent losses, the market is still slipping backwards in terms of rates. Aon Benfield, in its Reinsurance Market Outlook report, says that recent events have been insufficient to stop a continuing decline in US and European propertycatastrophe rates.

It claims that US property-catastrophe rates declined by between 5 and 10 percent in the April 1 renewals and it forecasts that the forthcoming June/July renewals period will see rates flat to down 5 percent for US hurricane-driven programmes.

“Throughout the recent, significant global events, reinsurance responded to the needs of global and regional insurers as intended, with material volatility shifted to reinsurers from the balance sheets and income statements of global and regional insurers,” says Bryon Ehrhart, chairman of Aon Benfield Analytics.

“Much greater stability in the regional insurance markets has been achieved as a result of effective reinsurance programmes, and affected insurers have gained new or reaffirmed existing respect for the volatility that can accompany frequent chance events.”

Pricing in Asia

While US property-catastrophe rates are predicted to remain flat in the forthcoming renewals, the situation is more complex in Asia due to the timing of the Tohoku earthquake on March 11—just weeks before the important April 1 Asian renewals.

Because of the disruption in the country, many insurers chose to extend current programmes while losses were being assessed, according to Aon Benfield. Where renewals did take place in Japan, rates on typhoon programmes increased by between 5 and 10 percent and earthquake programmes by between 25 and 50 percent.

“Understandably, a number of the major Japanese insurers have paused the renewal process while they take time to assess the impact of the tragic earthquake and tsunami,” says Bryon Ehrhart, chairman of Aon Benfield Analytics.

“However, the reinsurance market remains functional with its existing capital base, and we do not anticipate the need for material new capital flows into the reinsurance market to satisfy insurer demand for catastrophe reinsurance based upon the global events to date. Just as we witnessed following the regionally significant Chilean earthquake in early 2010, the reinsurance market continues to offer the capacity required by insurers at terms and conditions that remain lower than the cost of insurers’ equity capital.”

According to Guy Carpenter, the Tohoku earthquake will likely become the most expensive insured loss outside of the US on record, with current modelled estimates predicting an insured loss ranging between $12 and $30 billion. And the broker says this has—and will—continue to increase rates.

The broker says that most companies were able to renew unchanged capacity for pro rata treaties at the April 1, 2011 renewal, despite the earthquake occurring during negotiations.

But some things did change. Typical ceding commissions for this kind of business typically range between the low and high teens. In most, but not every case, these commissions were reduced by up to 3 percent in order to achieve placement goals. Guy Carpenter says reinsurers also sought greater detail on primary underwriting practices.

In terms of excess of loss protection in Japan, there was more of a mixed picture. Many of the larger programmes, in particular for the large mutuals, extended their programmes by up to three months, while the remainder opted for a 12-month renewal, as usual. Rates for renewing treaties varied between increases of 15 and 50 percent, and were dependent on individual circumstances, says Guy Carpenter.

The quoting season for windstorm business started just prior to the Tohoku earthquake. Lead reinsurers initially quoted modest increases ahead of negotiations, but there was a widespread expectation that small reductions would ultimately be available.

Following the March 11 Tohoku earthquake, however, insurers were not able to press for reductions and most elected to take up quoted pricing, says Guy Carpenter. The result was that windstorm rates for those programmes increased by 3 to 10 percent. Capacity remains tight for this line of business.

Programmes agreed early were often renegotiated following the earthquake and capacity needs were subjected to heavier scrutiny. Because of the uncertainty in the market, reinsurers were more willing to cut back on their support of a programme if pricing did not meet expectations.

In reviewing the relationship between the rate on line (the amount charged) and the loss on line (amount of risk) for the April 1, 2010 and 2011 renewals, pricing was flat to up very slightly, says Guy Carpenter.