Last year saw property reinsurance results go through the roof, but many believe these balance sheet figures are built on pretty shaky ground. We ask what will happen when loss patterns return to normal

Property reinsurance seems to have survived the global economic crisis in better shape than the rest of the financial sector. In fact, it enjoyed a banner year in 2009, posting bumper results on the back of improved balance sheets and, of course, the lack of any significant natural catastrophe claims.

But rather than being a turning point in the sector’s fortunes, 2009 is increasingly looking like just a brief hiatus from the established downward trend that began in 2007. Property/catastrophe rates took a downward turn at the 1 January renewals and most expect the soft market to continue diluting earnings from property reinsurance over the next two years.

“In terms of property treaty, 2009 was a stand-out year, but there was a remarkable lack of losses,” Willis Re International & Specialty chairman James Vickers says. “You can’t say the pricing is marvellous because the fact is, it isn’t. The property reinsurance market is still softening, even if the results are stupendous. Results were only good because of the lack of losses, not because the rates are attractive.

“If there are no more big losses for the rest of 2010, it will be another very good year, notwithstanding what’s happened in Chile and northern Europe so far. Everyone will think they’ve been jolly clever, but they’re not jolly clever – they’ve just been lucky.”

Stuck in the mud

So what is holding property reinsurance back? The continuing downward trend on rates stems mainly from the lingering effects of the financial meltdown. As the recession continues to unwind, there is still a reduced demand for insurance, which in turn is keeping prices low. “People want to have some growth, or at least to protect their portfolios,” Vickers says. “But if you look in the commercial business, the real economy is still hurting, so how do you turn round to people and talk about rate increases? It’s very difficult to make any of that stick.”

But while rates have declined, they’ve hardly fallen off a cliff and not everyone believes the market is soft.

Broker Aon Benfield International’s chief executive, Dominic Christian, concedes that the property portfolio is not as well-paid as last year but insists it still has “very substantial margins” within it. And he’s not alone.

“The property market in the last renewal session had a comfortable price level,” Munich Re’s head of corporate underwriting, Heike Trilovszky, says. “Prices had been under pressure for a while but they are still at a reasonable level and the changes haven’t been overly dramatic. If nothing major happens, that is also what I expect for the next year.”

And therein lies the rub. There are a number of factors that could adversely affect the market. Most obviously, what happens if the natural and man-made catastrophe environment is not as benign this year as it was in 2009? Insured losses came in at around $24bn in 2009, almost half the $52bn recorded in 2008.

So far this year, there has been the earthquake in Chile and Windstorm Xynthia across Europe. The combined cost of both events is estimated to be almost half of last year’s total insured losses. Chile could account for up to $8bn – most of which will be taken up by reinsurers – while Xynthia and the flood damage in Madeira come in at around $3.5bn. And we are still three months away from the start of the Florida hurricane season on 1 June.

Vickers says: “There’s an argument that you could have one peak-load loss in a year provided you don’t have any others, because people control that quite tightly. What will do damage is a series of medium-sized losses, however, and you could argue that we’ve started the year off with what is in global terms a medium-sized loss in Chile.”

Long odds

But natural and man-made catastrophes are only part of the picture. The insurance sector is facing diminishing releases from prior-year loss reserves, less investment income and tighter capital requirements in the shape of Solvency II.

And based on bond market expectations, inflation is set for a spike. “Inflation could become an issue, particularly for longer-tail writers whose premiums written today may be less able to cover inflated claims in the future,” Guy Carpenter’s managing director and head of global property specialty, Lara Mowery, explains. Trilovszky adds: “Within an inflationary environment, you won’t want to sit on a long-term portfolio, so some firms will move their portfolio away from long tail to short tail and that means pressure on prices.”

The crux of the problem is that in the current climate reinsurers lack the leverage to inject momentum into prices. “Traditionally, a soft market was driven by reinsurers,” Trilovszky says. “Reinsurers reduced prices and primary insurers followed. But in the last four or five years, we’ve seen the opposite. Primary insurers have been reducing prices but reinsurers have been more disciplined.”

Vickers agrees. “In earlier cycles, it tended to be the reinsurance market that led the primary market, but not anymore. One of the main reasons for that, in addition to insurers retaining more risk, is the structures they now use.”

Insurers are increasingly shifting away from proportional treaty, where reinsurers and insurers shared risk in a fixed proportion, preferring instead an increase in excess of loss, where the ceding company retains a deductible and pays a fraction of the premium to the reinsurer to take the peak risk.

“It’s been helpful for the reinsurance industry, of course, but that in itself is another problem because reinsurers are reporting these superb results while their primary clients are not doing so well,” Vickers says. “If you look at the comparative pricing movements, treaty rates have come down but nowhere near as much as some of the primary property rates.” That trend appears to be continuing despite the advent of Solvency II, which many felt would lead to an increase in reinsurance sales.

Against this backdrop, the odds on an upturn in rates in the coming year, or indeed in 2011, look long unless the sector is hit by a major loss event. “It comes down to that, or we’ll grind on like we are for another year or two until rates reach a level where loss ratios are 100% and they can’t stand it anymore,” Vickers says.

“I think the issue is: what will happen when loss patterns return to historic norms? Then the current underpricing will be revealed and you might begin to have some movement to address it.”

But Trilovszky says talk of a uniform decline in the cat market is overinflated. She says that while there was a downward trend in the UK, rates remained “stable to upwards” in Germany, France and Austria. “Austria had a couple of events the year before so price movements were relatively strong,” she says of the severe storms that resulted in price rises of up to 30% in the Austrian market.

Looking East

One bright spot is the sharp increase in property reinsurance catastrophe bonds as financial markets stabilised during the last year. “Before the fourth quarter of 2008, it was almost impossible to place a meaningful issue,” Aon Benfield’s Christian says. “In 2009, the market returned and we would now expect to see 2007 levels or greater in 2010. Issuers like the diversification that investors of a cat bond can bring to their overall hedging strategies.”

There is also the long-term potential for growth in China, although it is still some years away from being a mature enough market. “Cover needs are increasing in China,” Christian says. “But the big opportunities at the moment are in specialised lines like agriculture, which is a huge business. That’s not to say there isn’t the opportunity to expand property lines; it’s young and moving quickly.”

Vickers adds: “There were claims in China in 2008 due to the snowstorms, but while they were big for the Chinese market, they were not big in global terms. That said, I think in 10 years’ time a similar catastrophic event in China could produce a big loss. I wouldn’t be surprised in the not too distant future if there wasn’t a global peak exposure for Chinese earthquake and typhoon. They’re not there yet, but at the rate they’re growing, it will become an issue.” GR