With the reinsurance industry retaining its negative outlook, Nigel Allen reveals how those at this year's Rendez-Vous de Septembre were still positive as the renewal season approaches.

There were two storms battering the reinsurance sector as this year's Rendez-Vous de Septembre rolled into town. The first was Hurricane Fabian, a category two hurricane, which was tearing across the north Atlantic on a collision course with Bermuda. The second was the announcement by most of the large ratings agencies that, despite reporting significant profit increases in the first half of 2003, the reinsurance industry was to retain its negative outlook status.

Sustaining profitability"The hot issues are profitability and security," explained Charles Werner Skrzynski, Chief Executive Officer of XL Re Europe. "With all of the pressures we have seen on the ratings of reinsurance companies, even the larger ones, most have been either downgraded or put on negative watch because of what was regarded as an insufficient profit record, and I think that we all have to restore our profits and think about the bottom line." There was a general consensus among those attending the Rendez-Vous that the industry as a whole was under severe pressure to ensure that not only did it restore adequate levels of profitability, but that it did so in a manner which enabled it to guarantee that such levels, once achieved, could be sustained over the longer term - the so-called return to underwriting discipline.

Many reinsurers have reported increased profits in the first half of 2003 as a result of the hardening market the industry experienced in 2002, one which was clearly accelerated by the events of September 11. However, a number of attendees at Monte Carlo voiced their concerns about the ability of the industry to achieve sustainable levels of profitability going forward. Commented Lord Levene of Portsoken, Chairman of Lloyd's, in an address on the future of Lloyd's: "In the medium to long term, if we are to retain and attract capital in the insurance industry, there needs to be a radical change of thinking." He continued: "Don't get me wrong. The significant improvement in underwriting conditions across the market since September 11 is going a long way to rebuild insurers' and reinsurers' balance sheets. But the responsibility we must grasp for the future is to ensure discipline is maintained, in order to preserve a healthy, robust industry able to meet its obligations."

The biggest question, it would appear, is how reinsurers will react to the arrival of the next soft market, which despite some calls for a flattening of the cycle, is accepted as an inevitability and which, many suggested, is already being felt in some lines. This was a question which Hemant Shah, President and CEO of RMS, was keen to have answered. "From our perspective as a modeling organisation, it is understanding to what degree the industry can continue to exercise discipline in risk underwriting on the basis of objective risk analysis in the face of perhaps some suggestions that things are beginning to soften in some of the shorter property cat lines," he said. And it is clear that it will not only be the modeling companies that show an interest in the reaction of the market to the next turn in the cycle. "The analysts will be looking very carefully at how they [the reinsurers] handle the market going forward if it does start to soften," warned Callum Stewart, Managing Director of London-headquartered broker Heath Lambert Group, "and the loss ratios start to increase and the stock market increases do not have the required affect."

A rating reviewUnsurprisingly, the announcements by the rating agencies that the outlook on the reinsurance sector was to remain negative coupled with the recent downgrades of many of the leading reinsurers - and in particular that of Munich Re - in the weeks prior to the event, were to be found at the heart of many conversations over the duration of the event.

The negative outlook was maintained for a number of reasons, including concerns about reserve inadequacies, the duration of the hard market, the potential impact of a return to a soft market, particularly on profitability and solvency levels, and the continued volatility in the investment markets. However, the torrent of ratings downgrades that the sector has experienced in recent months, which has seen Moody's downgrade eleven out of 29 reinsurers in the first half of 2003, and Standard & Poor's downgrade seven of its `top 20 reinsurers' over the course of the summer, would appear to be slowing. Despite the prevalence of negative outlooks, the agencies, and in particular Standard & Poor's, were relatively upbeat about the sector, believing that it had perhaps now reached a turning point. In a release issued at the Rendez-Vous, Rob Jones, Managing Director at Standard and Poor's in London, stated: "We're nearing the point where we would stabilise our view of the reinsurance industry. Prices, and perhaps more importantly, terms and conditions, are holding up very well, and the market as a whole is earning money which will enable it to replenish, at least in part, the capital it has lost in recent years."

A number of practitioners raised concerns that the rating agencies were starting to hold too much sway over the direct day-to-day activities of reinsurers, to such an extent that they were now in a position to influence individual transactions. "You are seeing rating changes in reinsurance agreements," explained Alan Levin, a partner at US law firm Edwards & Angell, "in acquisition agreements and in commutation deals. So we now have a third party, which is not regulated, affecting commerce and the way companies do business."

That so-called `rating triggers' were becoming increasingly common was, as Peter Hughes, a director at Standard and Poor's in London, explained, a concern for the agency, and something which he described as "a dangerous tool", but added that the agencies had no power to prevent it. "It is the market which controls what happens in the market. We publish our opinion, our corporate opinion, and it is how the market reacts to that which governs what happens to the people in that market." He continued: "If you say that A is good and B is bad, you create what are known as credit cliffs... so that if we downgrade a company from A- to BBB+, which for us is a relatively small notch of change in the degree of probability of failure to meet obligations to policyholders, still the market can have an enormous reaction to it."

At the right priceWhile Rendez-Vous attendees were quick to rebuff any suggestions that the reinsurance industry is in the verge of a return to soft market conditions, it was clear that there are pockets of softening as a result of increased capacity and a lack of any significant losses in the last two years, particularly in some short-tail lines. Ross McKenzie, Chairman of Aon Re International, commenting on a recent pan-European survey, said: "Much of the evidence from our key reinsurance markets points to the onset of a soft market in some lines of short-tail business, particularly property and in some personal lines. Reinsurers are coming under intense pressure to cut certain rates in order to maintain market share and levels of premium income, pressure which will thoroughly test their resolve to maintain current levels of underwriting profit in the 2004 renewals."

However, while pressure is most certainly being brought to bear on reinsurers to reduce prices in these sectors, the majority continue to struggle to boost severely depleted balance sheets and strengthen inadequate reserve kitties, and many are keen to maintain rates at 2002 levels. Although, as Mr McKenzie added: "The supply and demand equation is likely to fall in favour of buyers, who, in absence of any significant losses or reductions in capacity, will be anticipating favourable rate reductions."

In contrast, it is not expected that there will be any similar fall in rates for some of the longer tail lines of business, where capacity remains tight and the pricing power is firmly in the hands of the reinsurers. Pricing on liability lines, particularly in the US, remains high, although there were some indications that new sources of capacity entering the sector and the subsequent pressure this places on reinsurers already established in the market could lead to a pricing review. "Liability has remained very much harder," said Callum Stewart, comparing it to property business. "However, just recently we have seen some easing in upper layers of liability covers on the more catastrophe end."

With the renewal season fast approaching, it is to be expected that the issue of pricing would be high on the agenda of most delegates, although there were suggestions that it had been knocked off the number one spot this year. Geoffrey Bromley, Chairman of Guy Carpenter in London, believed that pricing was no longer the only driving factor in the lead up to the renewal season. "It is appropriateness of cost rather than the cheapest price, and I think it is more on the quality of the solution that is going to be delivered. That is what I am hearing more and more at this Rendez-Vous, and that is a big difference from prior years, when price was certainly number one on the agenda." He added: "I think that clients are going to be a little more demanding this year. In the past few years, the issues of availability of coverage and indeed price of coverage have figured prominently. I think that more time will be spent on efficacy of covers and considering whether what is being provided meets the needs of the clients."

A further factor which may contribute to reducing the influence of pricing is the increased use of modeling and the more sophisticated nature of the models. It is now no longer a case of, "Do you model?", but rather, "What model do you use?". As Henry Keeling, CEO of XL Re, explained, many reinsurers, and especially in the property cat area, are employing as many as three recognised modeling systems, which "should argue that the cyclicality of the market may be compressed, reducing volatility because everyone has access to the same benchmarks." His comments were supported by those of Mr Skrzynski, who said: "We have more sophisticated models and are relying on more comprehensive statistical information. I think that everyone has understood from the cedant to the broker to the reinsurance company that the more reliable and comprehensive the information, the better the exposure taken by the reinsurer can be assessed, the retention kept by the cedant, and the price of the commodity itself, which is the reinsurance cover."

In contrast, while reinsurers are increasingly implementing modeling systems, the same does not appear to apply to technology in general. The industry seems determined to hold onto its status as one of the most technophobic in the financial services marketplace. Moves are afoot in the London market to address this issue. Commenting on the implementation of the London Market Principal slips and developments in relation to the establishment of the Kinnect platform, Lord Levene said: "Collectively, as an industry, we have a responsibility to get smarter about technology. About using it to model and understand risk. About harnessing it to revolutionise processing. About using it to deliver the insurance product more efficiently." What astounded Robert Gogel, CEO of RebusIS, was the lack of discussion about how reinsurers were addressing bottom line profitability. While he agreed that on the income side, rate adjustments and improved risk assessment provided a possible solution, on the cost side he warned that, "unless there is some significant cost taken out of the system through technology, I'm afraid the industry will continue to be plagued by profitability going forward."

Monaco aftermathDespite the storms buffeting the reinsurance industry, Monte Carlo was beset by a sense of poise, a belief that perhaps the worst was over. "I get the feeling that the industry is calmly addressing the very major issues that it has to resolve," said Michael Butt, Chairman of Bermudian `Class of 2001' re/insurer AXIS Capital Holdings Ltd, "in terms of its capital needs, its ability to hold and create profit, to rebuild balance sheets that have been destroyed." But he warned that this process was far from over, stating that, "there is still damage to come."

It will be interesting to see whether the industry can live up to its current air of conviction, and hold its nerve when the hard market begins to melt in earnest, rather than following the tried and tested route of chasing the market down. As Moody's makes clear in its `Global Reinsurance' review, if it is to maintain its credit rating upon the onset of a soft market, "the reinsurance industry's commitment to maintaining adequate pricing will be paramount". Historically, it has failed to do so. However, with the return to disciplined underwriting strategies and the acceptance that equity markets are no longer a means of propping up ailing profits, perhaps this cycle will be different.

Nigel Allen is the Assistant Editor of Global Reinsurance.