If 2006 is another loss-making year, Habib Kattan predicts retro will change for good.
In the wake of the 2004 and 2005 hurricanes, this year's renewal season was expected, at best, to be challenging and at worst to be very difficult thanks to a shortage of capital and capacity. The reality was that in January 2006 capital and capacity were plentiful, but at a price.
Generally speaking, limits that were purchased at 1 January 2006 were higher than at the same time last year. Pricing was, in some cases, significantly higher than in 2005 and this was not particularly surprising as reinsurers affected by the losses of 2004 and 2005 struggled to return to profit. The combination of the withdrawal of a couple of retrocession reinsurers from the market early in 2006, the marked deterioration in 2004 and 2005 loss estimates, and the impact of the rating agencies' new capital requirements for writing retro business, triggered a further and significant hardening of an already distressed market. The April and July renewals of 2006 were, by common consent, the most difficult and frustrating in living memory.
New capital in the form of sidecars offering collateral emerged in Bermuda as a result of the rating agencies' actions. Initially the sidecars appeared to be focused on their business targets and their client base but with the increasing scarcity and demand for retro capacity, they seemed to lose direction and become somewhat confused. It appeared to many that their presence in the marketplace was opportunistic. The cover they offered was limited and pillared, and their pricing seemed volatile and erratic.
New forms of capital began to emerge towards the end of last year; products such as catastrophe bonds appeared to provide a workable alternative to traditional and scarce retro capacity but these proved impracticable.
Although apparent solutions to the retro capacity crunch of 2006 were available to some, for conventional buyers of retrocession there was no real alternative to the traditional method of risk transfer. Provided 2006 remains a benign year as many are predicting, there should be a future correction in the retro market meaning a return to sanity. However, should 2006 prove to be another loss making year, then the dynamic of the retro market is likely to change for good. Buyers will seek to retain much more of their risk and to create structures solely dedicated to the long-term protection of their own businesses.