With a number of investors looking to up their reinsurance exposure, Lindsey Rogerson considers why the market is so bullish
The recent turmoil and its promise of higher prices for hurricane affected business lines, is clearly causing excitement in some quarters, despite the drop in share prices of many of the listed reinsurers. In the last month, Hiscox Insurance Portfolio has increased it exposure to the reinsurance sector by 4%, from 17.9% to 21.9%. This change to the fund's reinsurance exposure is significant at it was held pretty much at the 17% mark for all of 2005.
Guy de Blonay, manager of New Star Asset Management's Global Financial fund, is also enthusiastic about the prospects for reinsurers. De Blonay, whose fund is up 51.75% in the last year and 183.27% over three years, told Global Reinsurance, "I'm bullish on reinsurance because pricing is up. But one should stick to tier one players, as the agencies are raising capital requirements and regional concentration can be detrimental. ACE is a top pick, so is RE. But the caution is for investors to be careful as 2006 will surely be another year of natural disasters, and that pricing, even if it's up, could still not be high enough."
De Blonay's comments pretty much sum up the general cautious optimism which has replaced the great expectations across the reinsurance sector at present. In the immediate aftermath of last autumn's hurricanes, many had expected prices across the board to rise sharply, but with most of the evidence now in for the January renewal season, it is clear such wholesale price hikes have not materialised.
Indeed analysts at Keefe, Bruyette & Woods believe that while the large losses from last year's US hurricanes may have stalled the arrival of a soft market, they have not signalled the start of another hard market.
However, others believe that the 1 July renewals will show significant price increases, putting the market's dissatisfaction down to a misunderstanding of the business being written.
Nick Martin an analyst on the Hiscox Insurance Portfolio fund explains, "In January, the actual fourth quarter earnings reports from some of the reinsurers were seen by the market as slightly disappointing and the main reason for that is that the reinsurers talked the actual level of premiums down - which Wall Street misinterpreted. Primary insurance companies are retaining a lot more of the risk because they only have a limited amount to spend on reinsurance so what you have actually got is that the reinsurers are showing flat premium growth but it is significantly better quality business."
Fund managers will be keeping a close eye on exactly what business a company is writing, as well as the experience of underwriters doing the writing because Rita et al were the final nail in the coffin for existing catastrophe models. In a recent broker note JLT Re said, "The unforeseen frequency and severity of the 2005 catastrophic events has brought the reliability of the existing catastrophe models into question. Despite a significant amount of rethinking and recalibrating by modelling companies, there is still a general lack of confidence in the modelled output. It remains to be seen how quickly the modelling companies will restore confidence, and in the short term we are likely to see a greater emphasis on the interpretation of results and a drive to support model estimates by other means."
As touched on in last month's article with the true impact of 2005 hurricanes on bottom lines still a good way off, credit ratings are proving increasingly important among cedents when looking to place business. They are also crucial for reinsurers raising capital either to replenish reserves or to allow them to take advantage of the newly profitable post-Katrina business streams, much of which business will be written in July. Of the effected business written to date, marine and energy risks with exposure to the Gulf of Mexico saw premium increases of up to 300% (compared to a 10% increase for non Gulf business).
Reinsurers were already reviewing the way they wrote hurricane exposed business before the 2005 season, but further evidence of caution emerged in January. According to JLT Re, reinsurers have begun to impose event limits on insurance programmes and crucially not just those with Gulf of Mexico exposure. Such tight underwriting discipline is appreciated by fund managers and analysts alike.
Swiss Re/GEIS acquisition
Swiss Re's purchase of General Electric's reinsurance business for around £4bn late last year, makes it the largest reinsurer in the world. The deal was generally viewed by market watchers favourably as it is believed that under Swiss Re's leadership GEIS will be able to get back on track (GEIS lost $700m in the last five years). Hiscox says it is comfortable with the integration plans.
In May 2005, when we last looked at the US reinsurance market, a cloud hung over many players on the back of judicial investigations into certain retrocession contracts. In the last few weeks, however, clarification has emerged from the New York Insurance Department on the use of finite reinsurance going forward. Retrocessional cover played a significant role in protecting reinsurers after Hurricane Andrew in 1992 and US Re's chairman Tal Piccione, who sought the clarification, said he believed it would be essential in the wake of 2005 hurricanes. According to JLT Re, retrocession rates were up between 40% and 50% at renewal, although others put the increases at nearer 300%.
Hiscox's Martin believes that total capacity in the retrocession market has been slashed by up to 40% in the last few months. He said, "There is a lot of captivity coming out of the retro market which is quite important.
PXRE has effectively blown up in the states - they are not going to be able to write anymore business. They were not a massive player but sizeable enough. Swiss Re have bought Employers Re (from GE) and have decided to discontinue the retro business from the London market so that is a big loss of capacity and then Berkshire Hathaway seems to have doubled their prices overnight."
In fact Berkshire Hathaway is one of the companies Hiscox have been topping up on, not least because the manager feels the reinsurer's strong balance sheet (rumoured to be sitting with $40bn in cash) coupled with its strategic decision to diversify out of retro into larger national catastrophe business mean it is "holding all the cards at the moment". Another holding being topped up is Partner Re.
Finally, some analysts are excited about the prospects for new business lines. One such area highlighted by Willis Re as still underdeveloped but an "opportunity" for those quick to grasp the complexities, is pandemic reinsurance. Dan Bolger, an analyst at Willis Re said, "Pandemic threat has become the number one topic for discussion in the catastrophe market this year end. Conceptual reinsurance solutions have been initially viewed by prospective buyers as too costly. Capital market solutions in the US have allowed for some distribution of this risk for the larger life writers."
However, Martin is less convinced of the merits of untested business streams saying that he would have concerns if any of the reinsurers they held suddenly started writing such business.
- Lindsey Rogerson is a freelance journalist.