In the lead up to the 2005 renewals season, the reinsurance market echoed to the cries of "maintain underwriting discipline", but, asks Nigel Allen, did these cries fall on deaf ears?
Were underwriters able to maintain underwriting discipline in the January renewals or did they ignore the cries of regulators, rating agencies and senior executives alike and go on the hunt for market share? Initial indications are that on the whole prices continued to soften in the face of pressure from buyers and brokers for downward readjustments.
"While 2004/5 renewals were orderly, there were signs that competitive pressures are increasing in some sectors," said Grahame Chilton, Chief Executive of Benfield, following the release of the reinsurance broker's report into the January renewals, 'Outrageous Fortune'. "And though an increased use of modelling and a sharper focus on return on equity continued to exert some discipline, more and more reinsurance underwriters were willing to undercut pricing to secure attractive business."
It is not, perhaps, surprising that some underwriters were unable to maintain rates at 2004 levels, as most commentaries on the renewals season have indicated that price was paramount for the majority of reinsurance buyers. Indications were that reinsurance budgets were set in stone and failure to achieve desired rate levels resulted increasingly in retentions rather than any shifting on price. Most commentators suggested that reinsurance spend this year was on the whole flat and in some cases down on previous renewals.
However, these price cuts have been kept, according to Standard & Poor's, to "sensible levels". Stephen Searby, a credit analyst at Standard & Poor's, said: "Early evidence from the January 1 treaty renewals is that while reinsurance premium rates are still softening, the declines remain orderly - generally in the region of 5%-15% for loss-free accounts. For loss-affected accounts and Caribbean risks, generally rate rises of up to 35% have been achieved, but this is only a small subset of the industry."
Line by line
Despite a quadruple hurricane hit coupled with a devastating barrage of typhoons which should have left the reinsurance market reeling on the ropes, the industry seems to have soaked up most of the shots on its profits, with no real impact on capital. Early suggestions that the storms would put the brakes on any further softening in the property catastrophe market and might even see rates begin to rise again appear somewhat off the mark.
While loss affected programmes were always going to see rate increases, which according to Benfield ranged from flat to up by over 20%, globally property cat rates continued their downwards trend. As Warren Neale, managing director, Willis Re, said in their renewals review, "The effects of numerous hurricanes and typhoons were only expected to have a pricing impact locally on loss affected programmes and not on the global market."
On a region-by-region basis, Benfield reported that Central & Eastern Europe (CEE) and South Africa experienced the most marked downward movements in property cat prices, each recording slides of between 10% and 20%, while Latin America saw prices slide by approximately 15%. The report cited no major catastrophe losses and improved risk quantification as the reasons for the CEE rate dip. As expected, the Bahamas, the Cayman Islands and Grenada, each severely affected by the storm activity, were subject to hefty price increases, ranging between 25% and 50%. However, despite this, the wider Caribbean region has experienced price declines of 5% to 9%.
While capacity in most classes was described as plentiful, Benfield drew attention to the potential impact of capital from hedge funds underwriting property catastrophe which the broker said could prove a "destabilising factor". Furthermore, Mr Neale of Willis Re added that the appeal of hedge funds was growing as a means of eradicating continuing concerns over credit risk in the reinsurance buying process. "Recent forays into the traditional market by hedge funds offering fully collateralised capacity thus eliminating most if not all of the credit risk," said Mr Neale, "has created interest in the buyers and one can expect this area to gather momentum into 2005 and beyond." Guy Carpenter also highlighted the emergence of hedge funds as a source of reinsurance capacity in its report on US reinsurance renewals, stating that, "At and around January 1 2005 we saw hedge funds playing a minor yet expanding role in negotiating and completing placements."
While the hyper storm activity of 2004 failed to make a major dent on property pricing, the hurricanes, and in particular Hurricane Ivan ploughed a deep furrow through the Marine & Energy market. Charlie Cantlay, deputy chairman of Aon's reinsurance division, said that while overall insured losses were still somewhat of a "moveable feast", current estimates put the figure at in the region of $2.7bn, with approximately 30% attributable to Physical Damage and the remaining 70% resulting from Business Interruption.
Breaking the sum down further, Mr Cantlay estimated that the composition was approximately: $1,205,000,000 - international markets; $178,000,000 US markets; $722,000,000 - OIL; and $596,000,000 - retained. Guy Carpenter, in its review of the Marine & Energy market estimated OIL's losses to be in the region of $500m. Describing 2004 as "the worst year in our 34-year history," Douglas Kline, senior vice president and chief operating officer at OIL said that its members could expect to see rate increases in 2005, but said that the extent of such increases had not been fully determined. In terms of the direct impact on pricing levels, Mr Cantlay indicated that the market was seeking a 10% to 15% rise in Gulf of Mexico energy exposures. On non-Gulf business the storms are expected to put pay to any planned price reductions, which were set to be in the region of 10% to 15%.
While it is too early to gain an accurate assessment of the potential impact of the devastating Indian Ocean tsunami of 26 December on the re/insurance sector, initial thoughts are that its effect will be limited due to the low insurance penetration in those areas hit.
The aviation market came under ever greater pressure to come down on rates as the market experienced a third year on the trot without any major losses. Once again the urge to maintain market share appeared to come to the fore in a sector which is 'suffering' from over capacity and most rates came down by between 10% and 15%. As Richard Sowerby, chairman of Aerospace Reinsurance at Willis Re, said: "There may be a time, whether it be in 2005 or 2006, when the reinsurance market may stabilise at the insistence of capacity providers in particular, but currently market forces are the prevalent factor."
On the casualty side, rate reductions were generally in the region of 5% to 10%. Unsurprisingly, however, the Directors' & Officers' reinsurance market "is expected to be as unfavourable for insurers as the primary market is favourable for consumers" according to Guy Carpenter, which cited a fall in rates in the original market plus concerns over short-term reinsurance capacity as contributing factors. According to their US reinsurance renewals report, capacity could decline as a result of falling rates on original D&O business which has seen some of the market stalwarts now reducing their commitments at a time when few other reinsurers are willing to pick up the slack. The report also cited the departure of Converium from D&O reinsurance following its recent ratings downgrade.
Furthermore, a "combination of falling excess D&O rates and an increase in securities class action settlements in excess of $50m is adversely affecting carriers writing pre-dominantly excess D&O," the report stated.
Medical malpractice rates continued on their present course, according to Benfield, with primary prices still rising but at a slower rate, while reinsurance rates moderated. As Guy Carpenter pointed out, while the capacity is available the major concern for buyers is the affordability of the cover, with the American Medical Association compiling a list of 20 US states which it deemed to be in "crisis" in terms of the affordability and availability of cover. However, a potential light at the end of the tunnel was the announcement by President Bush that 2005 would see the issues of medical liability and class action reform topping his list of priorities, stating that it was vital that the next twelve months see workable medical liability reform pass through Congress.
Further down the cycle
However, Stephen Searby believes that while underwriters are effectively managing rates at this particular stage of the cycle, concerns remain over whether a further downswing in the cycle will result in prices reaching unsustainable levels.
"By and large, pricing still remains above economic levels, albeit lower than 12 months ago," added Mr Searby. "Some further slippage in prices is likely, but for the time being the market is behaving in a relatively disciplined manner compared with the same stage in previous cycles. The critical issue is whether further declines can be halted in 2006 when prices, on their current downward trajectory, will begin to test the rational levels of returns."
Nigel Allen is editor of Global Reinsurance.