Property catastrophe reinsurance prices continue to fall. Is it Chinese water torture, asks Jay Cohen.

When Paragon Risk Management Services (a subsidiary of E.W. Blanch) released its semi-annual catastrophe price index for the January 1998 renewal season, not surprisingly, the data depicted a continued fall in average prices. Catastrophe rates in the United States were down by 10.2%, on average, from the level a year before. The index now stands 32% below its peak in July 1994 (following Hurricane Andrew and the Northridge earthquake).

The decline since then has been fairly steady. Prices are still considerably above where they were prior to Hurricane Andrew, and property catastrophe reinsurers are still earning fairly high returns (helped, of course, by the general lack of catastrophe losses). Given the trend, however, we are beginning to wonder how much longer reinsurers can say: "Yes, prices are down, but they are still at attractive levels."

Specialist reinsurers, which arose after Hurricane Andrew dramatically changed the property catastrophe market, have taken three different paths in reaction to the lower reinsurance prices.

* Diversify. A number of specialists, such as PartnerRe and, more recently, LaSalle Re have diversified into other lines of reinsurance. RenaissanceRe has kept its property focus, but is now writing primary property business, both commercial and personal lines.

* Find a partner. Four reinsurers which began as property catastrophe specialists have sold themselves to other companies: Tempest Re and CAT Ltd sold to ACE Ltd, while GCR Holdings and Mid Ocean sold to EXEL Ltd. Both ACE and EXEL have historically had casualty-dominated books of business, and the acquisition of property-focused companies represents an uncorrelated risk from their traditional core businesses.

* Stay the course. IPC Holdings is the only Bermuda based reinsurer started in 1993-94 that has maintained its focus on property catastrophe reinsurance. The company is 24% owned by AIG, a well diversified group that also has an ownership in Transatlantic Re. Should IPC move aggressively into other classes of reinsurance or insurance, it might be competing with its largest shareholder. AIG has historically had a long term perspective on most business lines.

Those companies that remain committed to the property catastrophe market are taking other actions to maintain returns on equity. For example, nearly every publicly traded Bermuda based reinsurer has returned capital to shareholders in one fashion or another during the past two years. Renaissance Re bought back a significant amount of stock while LaSalle Re and IPC have paid generous dividends. We are also seeing more multi-year deals as companies try to lock in at today's rates and provide more stability to their premiums.

Despite the apparent excess capacity, prices have not plummeted, nor do we expect them to. Unlike the late 1980s, Bermuda controls a significant percentage of this market. We believe these carriers will be more disciplined underwriters, and most of them use advanced underwriting technology that has changed the way property risks are priced and exposures managed. In addition, we believe the prevalence of corporate capital at Lloyd's will result in somewhat better discipline in that market. We also note that Bermuda based reinsurers are very sizeable providers of corporate capital and managers of syndicates. Still, the low double-digit reductions in pricing have been frustrating for reinsurers and investors alike, resulting in little or negative top-line reinsurance premium growth.

What about the stocks?

As for the stocks of these specialty companies, this lack of top-line growth certainly has put a slight damper on investor interest; however, we note that the top-line pressure is already reflected in the prices. For example, PartnerRe, Renaissance Re, IPC, and LaSalle Re trade at an average of nine times estimated 1999 earnings per share. The Merrill Lynch Property/casualty index is trading at an average of 13.6 times estimated 1999 earnings.

In addition, these four stocks have an average dividend yield of close to 4%, well in excess of the insurance group average of 1.3%. Further, this yield is understated somewhat because IPC has got into the habit of paying special dividends which are not reflected in the current yield calculation.

Consolidation has also been a driver of these stocks, and the Mid Ocean and CAT Ltd acquisitions gave a push to the other Bermuda based stocks. While there still could be other deals, we find the opportunities for future acquisitions to be somewhat limited. First, there are relatively few potential buyers for Bermuda companies. A US based company likely would not acquire one outright because it would have to pay US corporate tax on the earnings. The same is true for most European insurance companies.

The two largest companies in Bermuda, EXEL and ACE, have each bought two property catastrophe companies; we do not believe they have an appetite for another. Finally, the benefits of merging two property catastrophe specialists may be limited by the geographic concentrations of each company. In other words, for two property catastrophe companies to combine, the geographic fit would have to be a good one.

Jay Cohen is an insurance analyst with Merrill Lynch, New York. Tel: +1 (212) 449 5206; fax:+1 (212) 449 0209; e-mail: