Only a significant natural catastrophe loss in 2007 could hold back the inevitable softening of rates. Such was the conclusion of GR readers in our latest survey. Helen Yates presents the results
Hurricane Dean, the UK flooding and Winter Storm Kyrill are unlikely to stem the downward pressure on reinsurance premium rates. As the industry prepares for the start of another renewal season the dynamics look very different to a year ago. According to the respondents of our latest survey, rates in the run-up to the 1 January renewals are likely to remain stable or to soften moderately.
In 2006, the industry was still reeling from the impact of two highly active hurricane seasons. Recalibrated catastrophe models anticipated a period of heightened hurricane activity. This, along with rating agency pressure, led to a widespread re-evaluation of catastrophe exposures. Premium rates spiralled upwards and capacity withdrew from the market, particularly for US catastrophe-exposed lines. As the 2006 hurricane season got underway there was nervous anticipation of more storms to come.
None came. Apart from Helene, which brushed briefly past Bermuda, the North Atlantic was graced with some much-needed respite. A benign season combined with sky-high rates combined to produce record takings and even an underwriting profit. Ironically, after the record catastrophe losses in 2005, the dilemma now was what to do with all that excess capital. Many opted to return it to shareholders, and inflated dividends and share buybacks have characterised much of 2007.
Vying for business
Competition has become a challenge. New Bermudian start-ups, diversification into new areas and the ever-increasing presence of capital market solutions are now a major threat to established reinsurers. The race for market share in hot new domiciles such as India, Brazil and China was of some concern to survey respondents. "In order to get business, they are offering their capacity with reduction in premium levels," complained the MD of an Indian insurance broker.
“What is certain is that last year's capacity crunch has all but disappeared, although traditional retrocession supply has yet to return to its pre-Katrina levels
What is certain is that last year's capacity crunch has all but disappeared, although traditional retrocession supply has yet to return to its pre-Katrina levels. Respondents overwhelming believe greater competition and a benign catastrophe experience in 2006 are pushing down rates (see figure 1 for a line-by-line breakdown). It must be noted that the survey was conducted before the bottom fell out of the US subprime market and this could lead to rate hardening on professional liability lines.
As reinsurance capacity increases, the demand for the product could diminish. Thirty-six percent of respondents said reinsurance spend was likely to remain flat at the renewals; however an equal 36% said it may decrease marginally. None expected to see a strong increase in purchasing. Respondents identified risk retention and the growth of alternative capital market solutions as key drivers. "As primary insurers see their top line deteriorate, buyers will seek comparable decreases in reinsurance costs. Should these decreases not be recognised, reductions in layers purchased are likely," said one US-based reinsurance broker.
If the laws of supply and demand hold sway, softening seems inevitable, unless there are any major catastrophes. A massive 74% identified natural catastrophes as the most likely factor to affect premium rate movement in the next 12 months (see figure 2). Underwriting discipline, the level of new start-up capital, the outcome of the 2007 hurricane season and the level of alternative reinsurance capacity could also affect rate movement. "Everything is subject to the 2007 Atlantic hurricane season," said the group reinsurance manager of a UK-based insurance company. "If this is highly active (and costly) again, then all bets might be off!"
Whether Hurricane Dean is followed by destructive brothers or sisters, reinsurance pricing will not plummet dramatically. An impressive 77% said the peaks and troughs associated with the reinsurance cycle are less pronounced today than they were five years ago (see figure 3). The reason for this? New investors and non-traditional reinsurance are thought to be very significant. Eighty-nine percent of our respondents said new investors and alternative risk transfer had smoothed out the cycle.
“As demonstrated in the months following Hurricane Katrina, Hedge funds and private equity investors are quick to take advantage of a hard market
As demonstrated in the months following Hurricane Katrina, hedge funds and private equity investors are quick to take advantage of a hard market. Over $30bn of capital went into new start-ups and capital market solutions in the months after Katrina - a much-needed cash injection during the capacity crunch. The big increase in alternative capacity has taken some of the sting out of market fluctuations, said one London-based broker.
A less volatile reinsurance cycle is also thought to be down to better underwriting discipline, said 42%. Others identified the influence of catastrophe model revisions (34%), start-up capacity (33%), tighter rating agency requirements (25%) and higher capital requirements (25%). Interestingly, enterprise risk management (21%) and new regulation (15%) ranked low.
At the time of writing, Hurricane Dean was doing its best to get into the history books. Despite being a monster catastrophe 5 storm, it had made landfall in a sparsely populated area of the Yucatan Peninsula and was not anticipated to lead to major losses. But the season is still young and sea surface temperatures in the Caribbean are well above average. As cedants, brokers and reinsurers descend on Monte Carlo to discuss renewal pricing and terms, all eyes will once again be on the North Atlantic.
Helen Yates is editor of Global Reinsurance.