Scott Farley provides an overview of the recent renewals season, and asks whether the soft market is already creeping up in certain sectors.

If there has been one defining feature of this year's renewal season it is perhaps best summed up by the old proverb, better late than never. Negotiations have been complex and protracted. Many contracts slipped past their 1 January deadline and were still in the market well into the New Year.

As one leading London broker grimly reflected: "The renewal season has been typified by late orders from clients who then show some surprise that covers cannot be completed in a day." As a result there were "many long faces on brokers by 3 and 4 January, worried about orders not filled and clients exposed to losses."

In the months prior to the renewal season, speculation had centred on the strength, or possible weakness, of the hard market. A year ago, renewals had taken place in the immediate aftermath of the world's biggest ever insured loss. Pricing in many lines of business rocketed and this upward momentum following the September 11 terrorist attacks generally continued during 2002.

The question posed by many commentators, therefore, was could these increases continue to accelerate throughout year-end renewals.

Predictably, the picture that eventually emerged was not painted in simple black or white, but rather different shades of grey. For while there have been many signs of a classic hard market there have also been a number of other interesting features that suggest - in some areas at least - conditions may be softening already.

One trend that was conclusively proved was the growing number of market participants willing to use electronic trading for the placement of renewal business. For the first time, this year the renewal season began with a significant quantity of cedants, brokers and reinsurers already committed to doing at least some business online.

During 2002, the number of companies signed up as members of the inreon online reinsurance trading platform increased by 240% to in excess of 100, and in certain markets there was a genuine critical mass of membership. Generally, activity conducted electronically reflected patterns observed in the market as a whole.

Of the pressures driving prices higher, one of the most notable was the reduction in the number of reinsurers available to cedants and brokers. In Germany both Gerling Re and Victoria Re stopped underwriting. Other reinsurers withdrew capital from specific territories or lines of business.

Declining reputation

Meanwhile, few in the industry escaped negative assessments from the rating agencies. The declining reputation of reinsurers' credit quality was dramatically highlighted by Standard & Poor's, when in December the ratings agency pointed out it had downgraded 47 of the world's largest players in 2002 and upgraded just three.

This trend has been particularly problematic in liability lines of business where the need for high quality security is paramount because of the long-tail nature of the business.

Other troublesome influences included continuing poor investment earnings. With global stock markets plummeting further over the last 12 months and interest rates remaining low, reinsurers have had no safety net to guard against inadequate underwriting results.

The claims picture has also raised little cheer, with both rising costs for old claims and the threat of several new potential liabilities. The former has seen cases ranging from asbestos to the World Trade Center, while into the latter category fell the menace of corporate scandals in the US such as Enron and WorldCom. These crises and perhaps others, as yet undiscovered, are expected to bring significant directors' and officers' and other liability losses to both primary carriers and their reinsurers.

All of these difficulties have helped sustain the hard market and provide justification for underwriters seeking to continue imposing rate increases on their clients.

Many contracts have consequently seen jumps of anything from 5% to 25% depending on the territory and line of business. Proportional business became harder to renew, particularly in Germany, as reinsurers decided they could not persist with the poor results seen in recent years. This has applied to both treaty and facultative contracts.

Two areas that are still definitely in the grip of a hard market are liability and motor. For brokers in London this has meant that individual reinsurers have had to be treated as leaders. Rather than agreeing a single lead price for others to follow, each deal has in some cases been hammered out one-to-one. For property, finding underwriters willing to take large lines appears to have been relatively straightforward. But then placing the remaining 10% or 15% has been much trickier, with many reinsurers not deeming such shares to be economically viable.

Evidence of a hard market has also been seen in Asia where 1 January renewals, as elsewhere, were very late. Many companies in Hong Kong, China and Taiwan were working through the Christmas holidays in an effort to finalise treaty programmes. Rate increases, cuts in commission and tougher conditions were all observed in the primary market, though the severity of these changes varied from country to country.

In Taiwan, Korea and Hong Kong, property rate increases were generally in double digits. There were also other classes such as motor and workers' compensation in Hong Kong where the rise was even higher and some employers' liability/workers' compensation for construction contracts even saw triple digit increases due to adverse claims experience.

Terrorism problems

For US-domiciled risks, terrorism issues continue to be a hurdle in the placement process. Indeed, it would be no exaggeration to say that this has been the single most frequent source of conflict in negotiations. The Terrorism Risk Insurance Act of 2002 greatly improved the ability of primary companies to make decisions and set policy, but reinsurers are not subject to the new bill and there were reports of further friction between the two camps. Primary companies were looking for reinsurers to follow their structure, but many were reluctant to be so accommodating. As discussions progressed there was further refinement of terrorism coverage on the subject of `domestic terrorism' (i.e. attacks from within the US like the Oklahoma City bombing).

Online renewal negotiations were just as keen as in the market overall. Given the very late nature of renewals, one major advantage of trading in this way was the ability to access several different reinsurers at the same time and receive speedy responses. Cedants and brokers making submissions via inreon were able to pre-select timeframes in which reinsurers were all obliged to respond. These periods could be as little as 24 hours.

However, a number of reinsurance buyers also chose to extend the process by using the system's capability for further negotiation. In these cases there were several examples of initial prices being substantially improved.

Altogether, of the 2,533 submissions made via inreon during 2002, 1,365 were made during the fourth quarter. This renewal business represented an increase of 275% on the amount transacted during the third quarter while the proportion of bound contracts between these two periods more than trebled. More importantly, though, it was also a 340% jump on the total in the fourth quarter of 2001, clearly demonstrating that this renewal was the first in which a significant number of market participants decided to at least begin trading electronically.

Softer picture emerging

Despite the many clear indications of a hard market, however, a closer look at the picture reveals several intriguing suggestions that, in some instances, at least softer conditions may already be appearing. For while notable price increases are still being achieved, a number of influences have been at work to undermine the upward momentum.

Of note is the fact that during the previous hard market peak of 1993, catastrophe modeling was still a fledgling science and the prevailing wisdom appeared to be for underwriters to charge more-or-less whatever the market would bear. Today, natural perils are reasonably well modeled and as a result prices are more stable. Terrorism models are also now becoming available for the first time.

Another critical factor has, without doubt, been the influx of new capital into the market. Bermuda has once again proved a magnet for new investors through the establishment of new reinsurers such as Axis Specialty and Montpelier Re, but new capital has also flowed into Lloyd's. Also in London, Wellington Re was established in June last year following a successful capital raising of £448m.

These examples, together with Gerling's struggle to find a buyer for its reinsurance operations, clearly indicate investors' preference for new start-up businesses rather than old established players. Cautiousness over existing entities is explained by an understandable fear of becoming embroiled in the uncertainties of ongoing losses such as asbestos.

New capital has effectively picked up the baton dropped by other reinsurers ceasing to write business. The process has necessitated a reshuffling of trading partners for cedants and brokers, and while not necessarily contributing to an immediate cut in prices has at least forestalled a capacity crunch. In short, decent business has not had trouble finding a home - providing, of course, that the price is right. Certainly, efficient use of new capital does necessitate an aggressive acquisition of business. Both Axis and Montpelier have joined the inreon trading platform in order to improve their access to both cedants and brokers. Price competition therefore, if not already making its presence widely felt, is inevitable and likely to be most apparent for large flagship accounts.

As this softening does become more apparent, so too will the industry's costs and inefficiencies. Generous pricing over the last few years may have helped mask some of the worst examples but as reality bites, companies will surely be forced to focus on profitability. This in turn will bring a renewed focus on electronic trading which has matured considerably in recent months. Statistics from the renewal period show more companies submitting more risks online.

In a report published by Standard & Poor's in December, Stephen Searby, global reinsurance specialist, commented: "We're seeing 30% 40% and 50% rate increases so we should be expecting combined ratios in the 80s but we're not getting that and we have to ask why. Reinsurers are paying brokers 25% and their own expenses are 15%; cuts have got to be made in brokerage and overheads."

Those companies that can achieve cuts in overheads by implementing efficiencies, such as those offered by trading online, will be much better placed to ride out the next market cycle. For while clearly most

1 January renewals were conducted in a hard market environment, there were plenty of signs to suggest that softer conditions may not be too far away.

By Scott Farley

Scott Farley is the communications manager for inreon. He has previously worked as a re/insurance journalist.