Tal P. Piccione surveys US market conditions and emerging trends, concluding that the industry of the new millennium is challenging, to say the least.
Traditional forces of competition driving prices down and heavy catastrophe losses putting on the brakes produce an accurate snapshot of today's reinsurance market. At the same time, however, some new players are moving to centre stage with unpredictable results.
While the power of the internet has yet to be felt in the reinsurance sector, new start-ups offering personal insurance on the World Wide Web are causing old-line companies to re-think their distribution systems. It won't be too long before insurers, reinsurers, and brokers will develop efficient ways to close reinsurance deals on the internet. The result will be a more open market for reinsurance and a further weakening of the “old boy network” that has governed our business for so long.
The capital markets also are poised to continue their challenge of conventional reinsurance with risk securitisation products that will become more competitive as the prices of treaty and facultative reinsurance rise. While traditional reinsurance and retrocessional protection will continue to be the primary means of covering the majority of a company's exposures, insurers increasingly will look to catastrophe bonds and other risk-based securities to protect against the upper layers of catastrophe risk. Multi-year financial reinsurance will compete with risk-based securities to cover these exposures. The choice of one or the other will depend on which is most cost effective under prevailing market conditions with respect to ART mechanisms. In the soft market of the last few years financial reinsurance has been more cost efficient than risk-based securities; however, as the reinsurance market hardens capital market mechanisms will provide an attractive alternative.
The first risk-based securities were issued with much fanfare nearly six years ago as a test of the concept. Some companies have arranged catastrophe bonds and other risk-based securities since then but the concept has not taken off due to the competitive market for conventional reinsurance to cover the same exposures. With reinsurance prices firming risk securitisation will be focused on increasingly. However, we'll have to wait and see whether bond investors will have a strong appetite for risk-based securities now that they've begun to lose principal from a recent occurrence. Just recently we witnessed the downgrading by Duff & Phelps Credit Rating Co. of $17 million in securities arranged by Halyard Re in a deal with Sorema, S.A. anticipating losses from European windstorms Lothar and Martin. This is an indicator of market caution, but it's too early to tell whether it will cause investors to shy away.
In traditional reinsurance we have evidence of hardening in the market. It began many months ago with a contraction in retrocessional capacity and a consequent firming of prices, and tightening of terms and conditions. This is renewing strong interest in US RE's Successor Products that offer multi-year protection and meet risk transfer standards of the Financial Accounting Standards Board at very competitive pricing levels. The usual January renewal season was extended this year as some reinsurers resisted higher prices and elected to shop around before committing. We continue to advise clients and prospects to consider our multi-year catastrophe excess of loss protection in the current environment of rising rates. They can lock in coverage and price for up to 36 months and not have to worry about a sudden shortage of capacity that could arise from a major catastrophe.
Anecdotal evidence points also to a hardening in the market for primary insurance. The combination of losses and the dismal performance of insurance stocks are causing investors to pressure managements to abandon the market share game and no longer accept grossly underpriced risks. While this apparent turn in the market may be heartening, bottom line improvements in profitability won't show up for at least a year. Also, experience shows that hard markets are short lived while soft markets live on for years. Looking ahead, we may expect profits to improve substantially over the next couple of years but the cycle is bound to turn as insurers reach for share in mature markets.
The turn in reinsurance markets also is being driven by the worldwide catastrophes that occurred in 1999. December's devastating storms in Europe clearly are putting pressure on reinsurance markets. Denmark experienced the most powerful storm to hit the country in 200 years early in December with losses of about $800 million. Then Storm Lothar swept across Europe at the end of the month followed by Storm Martin a couple of days later. EQE International, a risk management firm that specialises in catastrophes, estimated that insured losses for the late December storms will reach 5 billion euro. Losses from earthquakes in Turkey and Greece plus other disasters added to the pressure. In the US alone, total catastrophe losses for the first nine months of 1999 amounted to $7.9 billion, according to the Property Claims Service.
Looking ahead, Professor William M. Gray of Colorado State University, the national authority on hurricane activity, predicts a total of 11 named storms in the upcoming hurricane season. Seven will achieve hurricane status. He expects three of the hurricanes to be intense and says there's a higher than average probability (45%) that the US Atlantic coast will take a direct hit. Professor Gray's forecast is for the 2000 hurricane season to be more active than the long-term average but somewhat less active than the last few years.
Another major factor affecting today's market is continued industry consolidation. Perceived economies of scale and benefits of market dominance drive the consolidation engine but savvy independents continue to prosper. At U.S. RE we've elected to remain independent because we believe we can be more nimble and responsive to the needs of our clients than a huge organisation with layers of management that retard decision making.At the same time, however, we believe that brokers in the increasingly competitive market of the new millennium will not survive by doing business the old way. Consequently, we adopted a multi-faceted strategy based on innovation, diversification, global reach, synergistic investments, and strategic alliances. We've been committed to product innovation from the time U.S. RE opened for business 12 years ago. We led the way in developing multi-year, finite reinsurance that met FASB risk transfer standards, and we continue to offer a menu of new products.
In the past three years, we diversified our operations recognising that brokers today need more to succeed than shrinking commissions in a soft market. We offer our clients the full range of brokerage, consulting, and asset protection services. These include alternative risk transfer mechanisms, captive and rent-a-captive facilitation through our Bermuda company -
Uni-Ter International Insurance Company, and risk securitisation, plus the widest range of traditional and non-traditional reinsurance products. We have also begun to move into the wholesale arena through our U.S.RE Agencies unit.
Growing our international business continues to be a core strategy at U.S. RE. For many years we've been privileged to have important clients in Japan. Just last year we established a European headquarters in Basel, Switzerland, to serve our expanding business in the European Union.
Three years ago we created Fenelon Ventures, L.L.C., a wholly owned subsidiary of U.S. RE Companies, to engage in synergistic investments. As our merchant banking arm, Fenelon is seeking new investment opportunities in insurance, reinsurance, and related properties. In the last three years Fenelon has invested millions of dollars in the sponsorship and formation of a number of insurance entities and presently is reviewing new investment opportunities. We look for companies that are profitable for investors and provide synergistic opportunities for other members of the U.S. RE Group such as reinsurance production or captive insurance facilitation.
Alliances create mutually beneficial relationships. In 1998 U.S. RE Companies purchased a majority interest in Assurex Marketing Group, the programme development arm of Assurex International, the third largest retail broker network in the world. Operating as AMG/Quadrant Insurance Managers, the company is a managing general agency and programme developer with a wide array of specialised products. We work closely with Quadrant to develop programme business that benefits both companies. Our majority interest in AMG/Quadrant also brought us into a close relationship with the Assurex partners. U.S. RE offers these prominent brokers direct access to reinsurance that can be a critical factor in closing some deals with their clients and insurance firms. This is just one example of how alliances can build business for both parties.
Brokers who adopt a bold strategy of growth and diversification will succeed in today's market; however, they must be keenly aware of market conditions and emerging trends in order to apply resources to the most profitable opportunities. We believe the reinsurance and primary insurance markets will continue to harden through the year. But, more realistic pricing won't flow through to company bottom lines immediately so stockholder pressure will continue strong. We also expect a resurgence of interest in alternative risk transfer mechanisms and risk securitisation. Perhaps most significant, the internet will become an increasingly important distribution channel for small to medium commercial risks and less complex reinsurance transactions. The marketplace of the new millennium will be a high wire act with substantial rewards for those who keep their balance and no safety net for those who don't.Tal P. Piccione is chairman and ceo of U.S. RE Companies, Inc.