Downward pressure on pricing and the threat of regulation will make life difficult for the reinsurance industry in 2010. We talk to the market and ask what lies ahead
Reinsurers became increasingly optimistic during 2009 as the financial cataclysm of late 2008 turned into something more manageable. An absence of big hurricanes and an unexpectedly swift stockmarket recovery brightened reinsurer balance sheets. But will the optimism continue through 2010 or will the delayed reaction to the financial crisis, which has squeezed primary insurers, come to haunt reinsurance?
“It has been another benign cat season, which is good for reinsurance results, but it could point to pressure on pricing next year,” says Jeremy Brazil, president of Markel International Insurance Company. The stockmarket recovery has helped reinsurers’ balance sheets recover “faster than expected”, says Chris Klein, head of global business intelligence at Guy Carpenter. Overall, balance sheets at 30 September 2009 were “on average 8% larger” than at 31 December 2007, he says. However, Klein also points a warning finger at climbing casualty accident year loss ratios and a thinning of earnings support from reserve releases.
One of the main worries is inflation, which could drive up future claims compared with current premiums. James Vickers, chairman of Willis Re, says: “Current loose government fiscal policies will drive increased concern over inflation, which threatens both companies’ loss ratios and their reserves. Even if an increase in inflation is not fully manifest during 2010, growing concern will reduce the ability of companies to release reserves from earlier years.”
One of the most important predictions for 2010, according to Simon Barnes, director of non-marine at RFIB, is that “inflation will rise and this will impact future claims”.
What shape recovery?
It is unclear whether the current recovery in the world economy will continue. Will it be a U-shaped recovery or are we merely on the first upstroke of a W shape? The world economy grew in the second half of 2009. Some believe this will be the start of a long-lasting recovery, whereas others suspect we have not seen the worst of the recession and that the financial crisis has stored up worse effects to come.
“The recovery is fragile,” says Thomas Hess, Swiss Re’s chief economist. “Growth will generally be below trend in the major economies in 2010, but will accelerate modestly in 2011.” Swiss Re forecasts that by 2011, real GDP growth in OECD countries will be close to its trend of about 2% to 2.5%. Other parts of the world will do much better: overall emerging markets growth is likely to be about 6%, substantially higher than OECD growth.
To be prepared for 2010, it is necessary to understand the events that influenced the reinsurance industry in 2009. In addition to headline issues such as the benign catastrophe season and Solvency II, there was also a shift in mood. Post-financial crisis, we live in a more risk-aware world. As Yassir Albaharna, chief executive of Arig (Arab Insurance Group), puts it: “There has been an improved response to reinsurers’ benchmark pricing following the market changes. We also saw a general refocusing of underwriting discipline as a result of the economic downturn as well as a strengthening of corporate governance and risk modelling.”
This year also saw a resurgence of the subscription market, with the Lloyd’s model – despite rumblings from Brussels about anti-competitiveness – appearing an attractive way of diversifying risk.
Stephen Ross, insurance partner at Deloitte, says: “It has been interesting to see that the downturn led to a focus by insurers in managing their reinsurance counterparty risk, which has led to resurgence in the subscription market.”
Another consequence of the financial crisis has been an increase in regulation, and this looks likely to continue through 2010. Reinsurers are threatened by regulatory tightening across the world, and smaller domiciles are under threat, so 2010 could be a tricky year, even without any major catastrophes.
Law in general was a significant issue in 2009. Landmark judgments included Wasa v Lexington on differences in governing law, Equitas v R&Q on the use of accountancy models in claims in the LMX spiral, Chartbrook Ltd v Persimmon Homes on the interpretation of insurance and reinsurance contracts, and Swiss Re v Finanzamt München für Körperschaften, which decided that VAT is payable on portfolio transfers in life reinsurance from the subsidiary to the parent. Ramifications of all these judgments will continue throughout 2010. In addition, the European Commission softened its line on the Block Exemption Regulation. having previously suggested none of the rules would be renewed.
Solvency II will come into even sharper focus for European insurers and reinsurers in 2010, and there will probably be a compromise between the latest CEIOPS advice and QIS4.
There is likely to be good progress toward mutual recognition of Bermuda and other non-European reinsurance centres. In the UK, the FSA may become more intrusive, while in the USA, 2010 will be a make or break year for the Neal Bill, which proposes increasing taxes on foreign insurers that have US subsidiaries.
Possible regulatory changes in China could produce a healthier market. “The Chinese insurance industry will join the ‘international insurance standards’ being driven by their authorities and reinsurers,” says Seymour Matthews, chairman of reinsurance at Cooper Gay. As a result, the primary market in China “will head towards combined ratios below 100%”, he says.
In general, regulatory reform could drive demand for reinsurance, but this is unlikely to prevent a softening of rates; reinsurance rates in 2010 are likely to be flat or under downwards pressure. The softening will come from increased capacity and from primary insurers seeking high levels of retentions – though a major natural catastrophe could reverse this.
No one can accurately predict natural catastrophes, which is why a market in their risk exists. Matt Weber, a member of Swiss Re’s executive board and head of the property and specialty division, says overall nat cat losses “have increased significantly over the past decades and are expected to grow further”. Many see climate change as a cause of more frequent and more severe storms and floods in the future.
Whatever Mother Nature has in store for us in 2010, 2009 was a benign year for nat cat. According to figures from Swiss Re, the total cost to society of natural catastrophes and man-made disasters in 2009 was $52bn, dramatically down from $267bn in 2008. The cost to insurers was $24bn in 2009, compared with total insured losses of more than $50bn worldwide in 2008. The most costly natural catastrophe in 2009 was not in the US but in Europe: winter storm Klaus’s insured losses were about $3.5bn.
The unusually low 2009 hurricane season means that reinsurers will report strong financial results. But the greater capacity in the reinsurance market will have a downward pressure on pricing.
Most people expect reinsurance market pricing to be relatively stable or slightly negative in some areas. Subject to line of business and loss experience, overall property pricing could be in the range of flat to 10% down, with casualty flat to moderately down. Plentiful reinsurance capacity in the most crucial lines might encourage cedants to hold out until the last moment to gain the best possible deal. There will be exceptions – offshore energy pricing, particularly in the Gulf of Mexico, could buck the trend.
Retrocession in general could perhaps also be an exception to the rate reduction, although many expect it to ease by up to 5%.
Mergers and acquisitions
If rates overall are flat to soft, this will put the emphasis back on capital management. And the desire to use capital effectively could lead to a further increase in mergers and acquisitions. In 2009, Validus bought IPC, and PartnerRe bought Paris Re, and towards the end of the year there were persistent rumours that Ariel Re might be interested in a merger.
It is clear to many that mergers would make sense for many smaller reinsurers; with greater size comes greater security to offer to cedants. In addition, mergers often present an opportunity for cost savings, and provide a fast track into lines of business that would be more expensive to build into a company organically. As a result, 2010 could be the year of reinsurance M&A.
The man behind the largest merger of 2009, Patrick Thiele, chief executive of PartnerRe – who we interview on page 10 – has this to say about the future: “Looking ahead to 2010 and 2011, I’m optimistic for reinsurers who have a good understanding of what risk transfer is. Where we would like to see organic growth is in the non-life side in emerging markets, China and Brazil. This year will be an important year for Bermuda reinsurers to ensure group supervision and mutual recognition issues are resolved in light of EU practices.”
We cannot claim to foresee that 2010 will be an easy year. But having come through the financial crisis, the reinsurance industry has been stress-tested and is ready to meet the challenges ahead.
David Sandham and David Banks are editor and deputy editor, respectively of Global Reinsurance
Casualty danger zone
The lack of discipline in the primary casualty market in the USA has been sounding alarm bells since AIG became the insurance sector’s main victim of the financial crisis.
AIG, previously seen as a ‘gatekeeper’ that was keeping underwriting discipline – and prices – up, was in trouble, and decisions were made to secure a slice of this previously sewn-up business. Insurance companies lowered prices.
There was also an accusation that AIG, now state-owned, lacked the discipline it had once had and was writing at knock-down prices. However, the US Government Accountability Office, the investigative arm of the US Congress, found no evidence of under-pricing by AIG.
Whatever the causes, casualty pricing is now seen as too low. And experts are asking what will happen when inflation kicks in. Inflation will raise the cost of losses; then policies written on the basis of unsound underwriting decisions will suddenly be untenable.
Reinsurers have recoiled at the low pricing and many now think writing casualty is simply uneconomic. Swiss Re has already pulled back dramatically – it posted a 36% revenue decline in its casualty segment in 2008. Others say they will be writing a lot less and only favouring selected clients with renewals.
Joe Taranto, chief executive of Everest Re, echoes much of the sentiment in today’s market. “Casualty rates are thin – and getting thinner. We will remain extremely cautious in this area,” he says.
Ratings agency Moody’s has also flagged up warnings about rates. “With casualty rates continuing their downward trajectory,” says Moody’s vice-president James Eck, “rate adequacy in many casualty lines is tenuous at best.” According to Moody’s analysis, Bermuda firms with sizeable casualty businesses will be challenged because they remain vulnerable to changing trends in the cost of losses. Eck adds: “The existence of sizeable reserve releases, which have heretofore bolstered calendar-year underwriting margins, may be coming to an end.”
What will happen in the coming years will depend on levels of claims and increases in inflation. Bob Hartwig, president of the Insurance Information Institute, says: “The danger is real. The rates you put out on the street anticipated a certain amount of increase in frequency and severity, and they end up higher than what you anticipated.”
A critical moment in the development of technology in the (re)insurance market came towards the end of 2009, when the three top international (re)insurance brokers agreed to pilot the London Market’s “Exchange” for endorsements.
The Exchange – which was formerly referred to as the “Lloyd’s Exchange” – is a messaging hub that allows brokers, underwriters and system providers to have a single connection point from which they can send and receive information between multiple parties using the Acord standard.
Software providers are now engaged in a race to recruit insurers, reinsurers and brokers, and provide those parties with the tools that will enable them to access this and other (re)insurance messaging systems pioneered throughout 2009 and 2010.
Another important development in 2009 was the creation of the Claims Transformation Project. This London Market project is focused on enhancing claims as a standardised deliverable across the market.
“The Lloyd’s Exchange will finally show how many people have actually adopted the vaunted Acord standards – it will be interesting to see just how many are able to transact via this method,” says Richard Garnett, managing director of insurance communications hub Yellowblox.
Martin Eves, production manager at Total Objects, thinks that it is possible to glimpse the horizon where technology “ceases to provide the excuse to halt progress”. He says cloud computing, software as a service and service-orientated architecture all show the potential to remove barriers to reform.
Michael Graham, director at insurance software specialist Sequel, summarises the technological way forward. “The momentum for processing of electronic endorsements between companies will continue throughout 2010,” he says.