Reinsurance Renewals Clouded by Financial Turmoil

When reinsurers and their clients gather for renewal discussions at Les Rendez-Vous de Septembre in Monte Carlo in September, they will be anxious for evidence of stabilized financial markets while trying to read a mix of macro-economic conditions that could have profound implications on underwriting conditions.

Global financial turmoil has depleted the balance sheets of reinsurance and insurance companies alike. Under deteriorating markets conditions, capital and capacity availability are primary concerns of both buyers and sellers of reinsurance.

One key factor influencing negotiations for reinsurance renewals this year is "definitely" the supply and demand for insurance and reinsurance, said Thorsten Jeworrek, a member of the management board at Munich Re [85011].

"We're seeing two trends at present," he said in an interview in May, "Firstly, further capital-base reductions, with excess or even more capital being shed, and secondly, a lower demand for insurance on account of the recession."

Financial Crisis Impact

Low interest rates, widening investment losses and declining investment returns have limited the availability of fresh capital. When it comes to capacity, reinsurers have been pressed to deliver stable and profitable underwriting results because of weakening financial performances.

The financial turmoil has "dried out the offer of alternative reinsurance capacity because hedge funds and private equity investors are short of funds," said Rudolf Enz, senior economist at Swiss Re [85010]. Although securitization of catastrophe risks has recovered, life insurance securitization still suffers from market disruption for asset-backed securities.

The financial crisis has had a "considerable effect" on reinsurers' capital positions, which were down by 15% to 20% coming into 2009, said Andrew Appel, chief executive officer at reinsurance broker Aon Benfield.

This impact was "far greater" than any catastrophe loss in 2008, Appel said in an interview in June. As the crisis starts to ease in the absence of major catastrophe losses or influx of capacity this year, he said the hardening market "should begin to level off" in nonlife business.

Capital remains costly and difficult to acquire under ongoing volatile market conditions. There will be increasing pressure on pricing and terms for capital-intensive business lines, said Willis Re International chairman James Vickers in an interview in May. Portfolio diversification is required to lessen the pressure in a tightening capital environment.

Capitalization is expected to remain tight, with "no appreciable additional capacity being added in the short term," said Jeworrek. A capacity shortage is already "apparent" in big catastrophe and retrocession lines. This also puts pressure on prices for natural hazard and large liability programs, which requires high capitalization.

The financial crisis has three broad impacts on supply and demand of reinsurance for the 2010 renewal discussion, according to Chris Klein, managing director and global head of business intelligence at reinsurance broker Guy Carpenter & Co.

First, losses from hurricanes Gustav and Ike last year and asset devaluation have depleted reinsurers' balance sheets, which should "in theory restrict supply and put upward pressure on prices," said Klein in an interview in June.

Second, falling investment income has reduced support for underwriting, putting pressure on underwriters to maintain or widen technical margins.

Third, the recession "is causing reinsurance budgets to be reviewed with the aim of cutting costs," noted Klein.

Demand and Capital

Most insurers have faced sluggish premium growth in a tough economic and consumption environment. The recession has restrained premium hikes that would have lifted underwriting profitability against investment loss.

In the United States, total property/casualty premiums decreased by 1.8% in 2008, following 2007's 0.4% drop. This was "the first occasion" of premium drop in consecutive years since 1932 and 1933, said Klein. Decreasing primary premium rates, intense competition in most personal and commercial lines and loss of market share to non-U.S. players contributed to this downturn. All these factors, coupled with economic recession, act to suppress reinsurance demand.

However, the financial crisis has constrained insurance companies' capital tools "noticeably," and reinsurance is one of the few remaining possibilities to "swiftly" obtain the capital they need, said Jeworrek.

Vickers said insurers will place bigger demands on reinsurance in order to stabilize underwriting results. There will also be increasing numbers of smaller regional reinsurers who will stick to what they know best in the markets.

In the short to medium term, investment return is not expected to increase. With limited capitalization options, insurers can either reduce their exposure by writing less business or seek additional capacity through refinancing and reinsurance. Demand for reinsurance will increase, reversing the previous trend of increasing retention.

Recent signs of reviving stock markets have rekindled investment sentiment, as capital markets have stabilized by mid-June to a more normal level of volatility after extreme conditions in 2008's third quarter. Investors are more likely to put money back into security markets, buoyed by improving confidence, reinsurance experts said.

While the global economy is facing an uncertain time for recovery, the latest macro-economic developments will influence reinsurance negotiations for January 2010 renewals. Volatile equity markets remain a concern, although capacity conditions have not worsened through 2009.

"There is mounting evidence to suggest the capital markets are starting to re-open," said Klein. He cited a large Japanese insurance group issuing US$1.3 billion of subordinated debt and a large European insurance group that has raised almost US$2 billion to finance an insurance acquisition.

Capitalization of reinsurers "appears to be satisfactory and the absence of widespread rating downgrades supports this hypothesis," said Klein in June.

Signs of stability are more evident in the catastrophe bond market. In fact, 2008 was one of the top three catastrophe bond issuance years, although many questioned the viability of this risk transfer method when the market became silent in 2008's fourth quarter.

"Activity in 2009 demonstrates that risk bearers remain committed to catastrophe bond market," noted Klein. He cited seven transactions worth US$1.2 billion in risk capital, one of them by a first time issuer, by June.

The catastrophe bond and sidecar (special-purpose entities) markets "have successfully re-opened" in 2009, and specialty funds have raised capital to be deployed into the industry, said Appel in June. But he said "we have not seen a significant increase in other large sources of capital."

Pricing and Terms

April renewals showed rate increases in the United States and some big European programs, although there were no dramatic trends. Overall, there is a "general hardening" trend for reinsurance rates, said Vickers in May.

"The financial crisis has reduced reinsurers' capacity and prices have started to harden in general, especially for large capacities like property catastrophe covers. Also, special lines like aviation, marine and energy face higher prices," said Swiss Re's Enz.

Jeworrek said both insurers and reinsurers need rate hikes "simply because profitability is diminishing as a result of low interest rates." As reinsurance rates will look at impacts of premiums and claims, business lines with changes in claims development will an influence on pricing.

Credit insurance will see "a significant increase in losses due to higher default rates," and this has already led to "sharp price increases," said Jeworrek. Directors and officers and professional indemnity lines will see "the market hardening further down the road," with expected increases in loss frequency due to mismanagement, insolvency and a more prominent claims mentality, noted Jeworrek.

So far this year, Klein said reinsurance rates have risen but "not by as much as was expected from some of the headier predictions made in the third quarter of 2008" when the effects of the financial crisis and hurricanes Gustav and Ike started to unfold.

"Looking ahead and in the absence of a major financial or catastrophic shock loss, we expect the market to drift and price competition to increase," said Klein. "An 18% increase would have been needed just to return to the status quo and price rises were far below those achieved after hurricanes Katrina, Rita and Wilma [in 2005]."

"The steepest price rises have been where expected vis property catastrophe for areas hit by Hurricane Ike last year, Gulf of Mexico energy and financial institution D&O and [errors and omissions] liability," said Klein.

"General casualty is flat and only programs where experience has been worse than average are up. Generally, there is no shortage of risk capacity for casualty," said Klein. "The property retrocession market has not dried up and it is possible to place new U.S.-exposed retrocession programs at the right clearing price."