Nigel Allen delves into the problematic January renewals
It is that time of year for delays. Every day, millions of people around the world spend hours standing on exposed train platforms or in overcrowded airport waiting lounges staring disconsolately up at departure boards, which read "Delayed ... Delayed ... Delayed ..." And the most likely reason? Bad weather.
Very few would describe the devastating hurricanes that tore up the Gulf coast in 2005 as "bad weather", but the effect on the renewals season has been the same, with delays being reported on most lines as cedants, brokers and reinsurers continue to hammer out coverage details well into 2006.
Charlie Cantlay, deputy chairman of reinsurance at Aon UK, summed up the 01/01 renewals by describing it as, "One of the most difficult, problematic and argumentative renewals seasons ever," resulting in 2006 being one of the latest seasons on record. Despite some bullish comments in the latter parts of November and early December that renewals were proceeding on track, the utter chaos which the reinsurance sector has been thrown into in the aftermath of Hurricanes Katrina, Rita and Wilma, meant that come 01/01 there was still much business waiting to be placed.
While expectations ahead of the renewals were that strong rate hikes would be experienced across all lines with astronomical rate hikes predicted for those sectors and regions directly impacted by the storms, the renewals have not lived up to expectations. It is clear that immense upwards pressure has been brought to bear on the loss-affected lines of property catastrophe, marine & energy and retrocession all narrowly focused on the US Gulf region, but outside of these areas, rate rises have been relatively muted, with the knock-on effect of the storms being more of a stabilising factor on those lines which have been experiencing softening rather than a contributor to strong increases in pricing.
THE CAUSE OF THE DELAY
Before ploughing into the impact of the hurricanes on specific lines of business, it is necessary to consider the overall impact of the hurricane season on the reinsurance industry in an effort to explain why we have not seen a blanket rate hike and why even rate increases on exposed lines have not reached the vertigo-inducing levels that were predicted.
Based on preliminary analysis of storm losses by ISO's Property Claims Services unit, total catastrophe losses for 2005 were put at $56.8bn, with Katrina, Rita, Wilma, Ophelia and Dennis accounting for $52.7bn of the loss. In terms of the market split of the losses, insurers and reinsurers are expected to be "even stevens", with each picking up 50% of the loss.
But this loss must be considered in the context of three very profitable years for the insurance industry, culminating in the US property/casualty sector reporting a profit for the first half of 2005 of $13.3bn. This profit was of course wiped out by the third quarter storm losses, which left the sector sitting on a loss of $2.8bn as at 30 September, according to AM Best, but even so, the sector was still able to keep its combined ratio below 100% through September ... just (99.9%).
It should also be noted that unlike in previous instances of major insured losses, such as 9/11, where a major influencing factor on reinsurance renewals rates was a lack of capacity, as Guy Carpenter points out in its US reinsurance renewals report, apart from large placements, this time the impact on the market was indirect, "as all key players in the marketplace (insurers, reinsurers, modelers, rating agencies and regulators) recognised that the existing viewpoint grossly underestimated both the frequency and severity of North Atlantic hurricanes."
The market is undergoing a major reassessment of the methods it employs to evaluate risk, as 2005 was yet another year when risk models were severely tested and found wanting when faced with major catastrophic losses. As a result, reinsurers are having to up their loadings on catastrophe model outputs, and factor in an uncertainty element into their pricing of business.
Furthermore, they are now having to place much greater weighting on demand surge cover, an element which was previously relatively unmodelled.
It is therefore not surprising that basic elements of underwriting are reasserting themselves on the market, as reinsurers demand ever-greater amounts of information from the cedants prior to accepting the risk. As Chris Clark, CEO of Willis Re Specialty says, "The fact that the models failed to accurately predict how much damage a large hurricane would wreak going through the Gulf of Mexico means that greater clarity is necessary as to the precise nature of the risk underwriters are asked to reinsure."
A further factor to add to the maelstrom in which the 01/01 renewals have been carried out is the impact of the capital adequacy reassessments which have been brought into force by the rating agencies. AM Best, for example, announced in November, that it was to up its surveillance of the catastrophe exposures of both primary insurers and reinsurers and "continues to refine the methodology for evaluating insurers' financial strength to reflect their ability to manage the potential losses."
And for good measure, consider the fact that Standard & Poor's, when outlining its plans to implement a risk charge in its risk-based capital model from 2006 in December, also raised its concerns about over-reliance on reinsurance, with credit analyst Simon Marshall confirming that "our analytical assessment will become increasingly negative when a cedent's commercial strategy and competitive position are found to be overly dependent on an ability to lay off a major part of the 'working layer', as well as peak risks, to reinsurers."
Now that the scene has been set, let us consider the aftermath of the January 2006 reinsurance renewals.
RESTRICTED RATE HIKES
It has been well documented that this year's reinsurance renewals have revealed a stark difference between rate changes on the "loss affected" and "loss free" lines and regions. Looking specifically at the US property sector, the renewals have witnessed a major divergence in price hikes on national and regional programmes, with nationwide covers seeing the greatest upwards pressure. Guy Carpenter believes that regional programmes offer reinsurers a "more efficient use of capital" as it limits their exposure to territories, and hence the "more tempered" price increases.
Loss-affected programmes were subjected to rises of 30%-100% depending on the size of the loss incurred, while those programmes unaffected by the storms have had rate increases of 10%-20%. Benfield reported that for storm-hit programmes, first layer pricing came under severe pressure, with many cedants unable or unwilling to renew at the new level, but rather seeking to acquire additional limits at the top end of their programmes.
Guy Carpenter concurs, stating that there have been increased first layer retentions with a push to purchase more up top, adding that overall limits for national accounts rose by approximately 10%, while retentions rose 33%, compared to a 13% limit increase on regional exposures, with retentions rising 19%.
Outside of the US, while the catastrophic losses and the subsequent rise in capital allocations being imposed by rating agencies have served to stall a general decline in rates, it is the local market conditions which have tended to hold greater sway on price developments than the global impact of the hurricanes. The European markets had experienced catastrophic losses during 2005 in the form of Windstorm Erwin at the beginning of the year and the devastating floods that washed across Switzerland in August. It is therefore not surprising that Swiss property catastrophe rates rose in some instances as much as 20%, according to Benfield, while the Nordic regions directly impacted by Erwin reported price hikes of between 20%-25% on loss-affected programmes. Other regions such as France, the UK and the Netherlands experienced rate hikes of up to 10%, while most other regions reported either slight increases of between 1%-5% or flat renewals.
The retrocession market has been placed under severe strain by the battering it received from the hurricanes. Focusing on the non-marine retrocession side, Katrina tore straight through almost all US-exposed programmes, while Wilma, although still a developing loss, is also expected to burrow deep into retro cover, although not to the same extent as Katrina. The sector experienced a major set back in the run-up to the renewals with the announcement by a number of retrocession providers that they were either looking to sit this renewals season out, as was the case with Brit, or look to re-establish the level at which they were willing to sell retrocession, as did Berkshire Hathaway, thereby markedly reducing their participation.
According to Piers Cantlay, chief executive officer of reinsurance at Aon UK, worldwide retro capacity fell by approximately 35%, which proved a "major headache". Attempting to place worldwide retro cover has been nigh on impossible, with pillars of cover providing the main structure for most. This did not mean however that it was not possible to find solutions to clients' retrocessional needs, according to Benfield, stating in it renewals report that, "Whilst reinsurers supplied terms based on their new protocols (no worldwide cover/territory specific only, no direct and facultative cover within general programmes, so called 'pillared' terms with differential rating for specific territorial coverage etc) and higher pricing, generally flexibility on both sides meant that solutions were found."
For some companies, however, retrocession cover has simply become uneconomical at current levels, with most programmes seeing rates rises of between 50%-100%, and alternative methods have been sought, including the use of sidecars.
The marine & energy sector has witnessed the largest rate hikes. While losses are still described as developing on the impact of Wilma, current estimates expect the overall losses from the storms on the marine & energy sector to hit $15bn, with all classes impacted. Following hot on the heels of Hurricane Ivan in 2004, the previous biggest sector hit, it was to be expected that the marine & energy market would undergo the greatest upheaval of any sector.
Gulf-exposed programmes have seen price increases as high as 200% - 300%, while term and conditions have sought to impose heavy restrictions on Gulf of Mexico windstorm cover. According to JLT Re, whereas in the past marine underwriters have been able to place quota share treaties without event limits or loss caps, "In the post-Katrina environment, reinsurers began to impose event limits, in particular for programmes with Gulf of Mexico exposure." However, Benfield highlights the fact that the January coverages showed some improvement on that offered immediately after the storms, where it states "certain energy protections were purchased with no GOM (Gulf of Mexico) cover". On the retro side, scarcity has resulted in such cover becoming prohibitively expensive, with many exiting the January renewals without having purchased retro cover. Outside of the Gulf coast, marine & energy programmes have been subject to the ripple effect of the rate hikes, with prices on average being upped by between 5% - 15%.
THE KAT PACK
Despite some $8.5bn of new capital entering the market in the form of the Class of 2005 (total new capital was put at approximately $21bn), the impact of the new start-ups on the renewals seems to have been relatively limited. A key factor in this was that many of the companies entered the fray so late on in the build up to the renewals, with most only receiving their AM Best and Standard & Poor's ratings in the weeks immediately prior to the renewals. James Vickers, CEO of Willis Re International, also raised the issue of client relationships, saying that "with adequate capacity supply, most buyers have tended to support their existing reinsurers leaving limited opportunities for new reinsurers." However, while Charlie Cantlay believes that the new batch of Bermudan insurers and reinsurers had no real impact on pricing he did believe that the new capacity had allowed "some of the more difficult programmes to get placed."
Having said that, the new start-ups have not been completely left out of the loop, with a number of the new companies announcing that they have achieved their renewals targets. For example, Amlin announced earlier this month that its new Bermuda entity, Amlin Bermuda, had so far written more than $60m of new business which excluded intra group business ceded to it by Syndicate 2001, with Charles Philipps, chief executive of Amlin, adding that, "2006 has started well and Amlin Bermuda has had a very good reception from our UK-based brokers."
RETURNING TO A GOOD SERVICE
For anyone to be surprised that this year was the latest on record, given the chaotic environment in which the renewals took place, is in itself surprising. However, there should be an acknowledgement that there were factors other than the hurricanes and their repercussions, which have contributed to the delayed renewals. According to Nick Goulder, international director of casualty at Willis, "poor reinsurance practices" are to blame in some instances. "This season has produced many examples of reinsurers suddenly coming up with a list of complex requirements with their first quotation in early or mid-December, many of which were embedded in an existing contract which could have been raised last spring." Goulder added that a further hindering factor was the "passive wait for third quarter statistics". It is inevitable that as the market reevaluates the role of catastrophe models and calls upon cedants to provide ever-greater amounts of information to allow a comprehensive assessment prior to accepting or declining the risk, the renewals will become somewhat of a moveable feast. To counter this it is clear that all parties to the contract - cedant, broker and reinsurer - should make every effort to begin the process earlier. Perhaps we should consider a Rendez-Vous de Julie?
- Nigel Allen is editor of Global Reinsurance.