An initial confidence that rates would increase post-Katrina is dwindling in some quarters, but not in others Lindsey Rogerson asks why.

Giving a preliminary snapshot of the 2006 renewal season, Wilhelm Zeller, CEO of Hannover Re, said he remained confident that 2006 would be a stellar year for reinsurance, saying that the post-Katrina effect on pricing had barely begun to be felt. A similar confidence is emanating from Munich Re, which has announced it will pay a dividend to shareholders up 55% on last year despite unprecedented natural disasters in 2005.

However, comments in other quarters, namely the brokers and analysts, sound a more cautious note and could even lead one to conclude that all of the optimism of last year has evaporated. Summing up this sentiment, Keefe, Bruyette & Woods said, "The stock market is now too optimistic about 2006 reinsurance renewal season. All property and casualty stocks have run up in the hopes of good news in the renewal season and are vulnerable to disappointment." So what is going on?

Uneven rate hikes

What is clear is that the across the board premium rises widely predicted in the aftermath of the US hurricane season have not materialised. Charlie Cantlay, deputy chairman of Aon Re UK, hits the nail on the head when he says a two-tier market has emerged post-Katrina. Businesses and lines directly affected have or will see premium hikes, but as Sean Mooney, chief economist at Guy Carpenter confirms, primary insurers have simply proved unwilling to accept rate increases on lines unrelated to the US storms.

This would in theory suggest that well-diversified businesses should be able to offset flat premiums in some lines with significant increases on others, namely US property, energy and marine rates. It is often said in business that companies must evolve or die. Hannover Re, the fourth largest global player, typifies such diversification. It is a very different beast from that of 15 years ago (see chart 1) with much greater diversity of business lines. A diversity Zeller believes has helped the reinsurer thrive, irrespective of what the rating agencies may think at any one moment in time.

Hannover Re had not published its full renewal figures at the time of going to press, although it has gone on record saying that its US catastrophe business has seen premium rises of up to 100% for loss affected companies.

But also that premiums had remained virtually flat for those who escaped hurricane damage in 2005. Zeller also said that reduced capacity in the marine market had strongly pushed up prices but that pricing in the professional liability market continued to decline. But what will this mean for the group and others like it?

William Hawkins an equity analyst at Keefe, Bruyette & Woods is less sure about how the large diversified European players will perform. Referring to a note published 9 January 2006, in which both Munich Re and Swiss Re were downgraded, with regards to the former, he said, "The recent doubling of the Hurricane Katrina loss estimate was a big disappointment and reduces operating earnings, even if it has no impact at the headline it calls into question the thesis of favouring large diversified reinsurers."

So if the giant European players can merely hope to offset increases in one area against flat or declining rates elsewhere then who will benefit?

Once again, as a whole, the reinsurance market has risen to the challenge of a horrendous series of catastrophic events. A host of new players flooded onto the market in the final quarter of 2005, to plug the massive loss of capital as capacity post Katrina, Rita and Wilma drops. The new kids on the block, most of which are located in Bermuda, are responsible for raising almost half of the $21bn of new capital estimated by Guy Carpenter.

The power of ratings

The time it takes to secure ratings means that the full impact of the new players on market share of the established companies has yet to materialise, and a key determining factor in winning business will ratings. Richard Morgan of Guy Carpenter explains that "to a certain extent, rating agencies were also caught out by the extreme loss experience of 2005. They took action by instituting a reassessment of the method of measurement and treatment of catastrophic risk and the capital required to support it. This reassessment will continue to be a factor for both buyers and sellers of reinsurance as the market moves into 2006 and beyond."

Ratings are doubly important in that they not only impact on a company's ability to borrow but they also influence a broker's decision when advising a client on which reinsurer to go with. Indeed Benfield's report on the reinsurance renewals, "Swings and Roundabouts", claims there is already evidence that clients and advisers are re-evaluating their reinsurers based on 2005 hurricane losses.

Benfield's CEO Grahame Chilton said that almost one third of cedants considered reinsurer ratings an important issue when placing business.

The report added, "The trend towards cedants being ever more security conscious continued. This was evidenced by the use of minimum rating requirements as well as questioning individual reinsurers as to PML management, given the impact of 2005 loss events on certain reinsurers."

Although the market is responding to these concerns. Benfield continued, "Many reinsurers responded to cedant concerns by raising additional capital or presented alternative mechanisms to give cedants a higher level of comfort regarding reinsurers' ability to fulfil their financial obligations.

Most cedants continued to have strict security guidelines, which typically prescribe certain criteria for their reinsurers such as minimum AM Best ratings."

Early indications suggest that the new entrants, be they Lloyd's or hedge fund-backed, have not attempted to win business by undercutting competitors, the latter in particular being content to offer cover only in very specific and limited areas. However, these niches could prove extremely lucrative, if predictions that the market for storm-related damage cover will continue to harden, prove founded.

Benfield sums up, "Recalibration of catastrophe models, a shrinking risk appetite for peak exposures, restructuring of coverage on a more restrictive basis and the increased cost of capital are likely to squeeze catastrophe capacity and exert further sustained upward pressure on pricing. Reinsurance capacity is likely to be significantly tighter for 1 July renewals and all the more so later in the year if predictions for the 2006 hurricane season prove accurate."

- Lindsey Rogerson is a freelance journalist.