In this review of current market conditions and the impact of consolidation, Edmund R. Megna concludes that in today's rapidly changing financial markets, one learns not to be surprised.
The United States reinsurance market in the latter half of the 1990s has been dominated by two factors: the soft market and consolidation. From my perspective, clients on the whole have benefited from both. First, I will review current market conditions and address the perennial question of when/if the market will turn. Then I offer my views on the impact of consolidation among clients (primary insurers), reinsurers, and brokers.
The past few years have been good for cedants. Prices have been declining, and capacity has been readily available. At the same time, primary insurers have benefited from a number of innovations, ranging from finite products to catastrophe bonds, which have expanded the traditional menu of reinsurance solutions. Given the softness of the market, it is not surprising that reinsurance premiums have remained basically flat for four years, as shown in Exhibit A, which is based on Guy Carpenter's Proprietary Composite Reinsurance Study. In 1998, net written premiums for the composite stood at $17.6 billion, practically equal to the level of $17.7 billion in 1995.
At the time of writing, there are some straws in the wind that suggest a market turn in both the primary and reinsurance industries. In the first six months of 1999, there have been a number of substantial catastrophe losses. Winter storms in January in the United States cost over $1.8 billion. A highly unusual hailstorm in Sydney, Australia, resulted in insured losses of $1 billion. Devastating tornadoes in the spring in the United States heartland cost about $1.5 billion. And the recent earthquakes in Turkey and Greece may cost insurers more than $1 billion. These property losses, none of which was devastating by itself, have had a cumulative affect of reducing reinsurers' appetite for risk.
In addition, the soft market already has pushed a number of reinsurers to the sidelines, notably in the Bermuda market. This market is highly sensitive to pressure from stock analysts, and Bermudian reinsurers prefer to maintain surplus capacity rather than deploy it at projected low rates of return.At this point we are expecting that, on average, prices will firm, and that some programs will have difficulty being fully completed. Barring a megacatastrophe, or an unusual accumulation of major disasters, a harsh, sharp turn akin to that taken in 1993 following Hurricane Andrew is not anticipated.
The primary market
Acquisition activity among primary insurers in the first half of 1999 was lively, with 15 transactions valued at over $100 million. Exhibit B lists acquisitions where the target is a United States or Bermuda-based primary insurance company.
In terms of mergers, consolidations are likely to slow down. There is evidence in the marketplace that some consolidations have not achieved all that was expected at their announcements. A stock market correction will also have a dampening effect. And let's not forget the United States Justice Department, which gets upset about monopolistic tendencies.
As our clients continue to consolidate, there is no question that their demand for reinsurance will decline. At the same time, we are finding that clients' needs are becoming more complex as they grow and that they have more need of modeling and actuarial services.
Reflecting in part the lack of growth in the market, reinsurers also have sought growth through acquisition (Exhibit C). The number of professional reinsurers included in Guy Carpenter's Proprietary Composite Study declined to 38 companies in 1998, down from 64 in 1992. This number is expected to continue to decline. Indeed, in June 1999, two of the largest independent reinsurers in the United States, Trenwick America and Chartwell Re, announced that they would merge.
As for the impact on clients of reinsurers' integration, I think it's actually beneficial. Generally, what we see in the market is that a medium-size reinsurer consolidates with another one of equal or greater size to create a larger, more financially stable reinsurer. So, as a result, the markets are much stronger financially than they have been in the past.
People talk about there being fewer markets, but our market list is still quite extensive. Let's compare the broker market in the mid-1980s to the broker market today. In the 1980s, although there was a multitude of reinsurers, a significant number lacked solid financial security. Right now we have more than an adequate number of reinsurers for placement, and their financial stability is substantially better than what it was during that period.
In my view, the most likely mergers have occurred among the major brokers. But in today's rapidly changing financial markets, one learns not to be surprised.
Following a merger, clients worry that they will lose a certain level of service they had come to expect. At Guy Carpenter, we have made our transition to a merged company as smooth as possible for our clients. The big difference for our brokers and clients is in terms of greater depth of resources. With the combination of all these acquired companies into one organization, brokers have much greater access to resources than they did at their individual company.
The broker of the 21st century
Years ago, intermediaries were traders and did not provide much analytical support. But those times have changed. Reinsurance buyers have become much more sophisticated, and are now so astute, that if a broker does not bring them new ideas - and have the resources to back them up - that broker will lose business.
Long-term, we at Guy Carpenter are looking to provide the most sophisticated tools and products to our clients. We have invested heavily in developing our quantitative services unit, Guy Carpenter Instrat. The unit employs state-of-the-art analysis, including actuarial and financial modeling capabilities, to address our clients' problems. Using Guy Carpenter Instrat's resources, clients can review the financial impact of many different reinsurance programs so they can make better and more informed decisions. I firmly believe we are well ahead of our competition in this area. Further, we have developed expertise in structuring finite risk reinsurance and other nontraditional reinsurance programs.
To respond to our clients' needs for access to capital markets, we have built a channel to investors through our sister company, Marsh & McLennan Securities Corporation, the investment-banking arm of MMC, our parent company. This gives our brokers the flexibility to utilize all the risk transfer options that are available.But in the face of all these changes, we still place a high value on basic broker skills. The successful broker of the 21st century will be one who understands and values client and market relationships, while still mastering a whole new set of financial skills.
Edmund R. Megna is president and ceo, United States Division, Guy Carpenter & Company, Inc.