Retrocession capacity is still a long way off from its pre-Hurricane Katrina levels. Paul Delbridge and Jean Bernard Crozet consider its value and the impact of non-traditional competition

With the run-up to the 1 January 2008 renewal season now well underway, it appears that the annual guessing game on the direction of reinsurance rates increasingly revolves around two key questions: How disciplined will the post-Katrina capacity be after last year's benign loss activity? And will non-traditional solutions continue to channel a growing stream of capacity from the capital markets?

The July renewal season has firmly signalled a softening in rates for US property catastrophe reinsurance and retrocession. This is the last major segment of the global insurance and reinsurance markets to have avoided the cycle downturn.

Inevitably, prices have now softened. The new players, often backed by funds from the capital markets, have entered the industry offering attractive rates against a backdrop of the very substantial rate hikes following Hurricane Katrina. Marine liability rates have also softened over the last 12 months, as these new players have necessarily found other competitive markets in which to deploy capital.

Non-US property cat reinsurance rates, on the other hand, have continued to soften since the 2005 hurricane season. Major typhoons and windstorms in Japan in 2006 and Australia in 2007 have failed to provoke comparable market shifts to those caused by Hurricane Katrina et al in the US.

Capital question

Questions remain around the longevity of the hedge funds, which have offered collateralised catastrophe reinsurance and retrocession protection since late 2005. In particular, will we see a sudden shift in their appetite should rate levels become too low to support their ambitious target returns?

Judging by the recent developments in the collateralised debt market, where capacity provided by hedge funds abruptly dried up, this certainly seems to be a possibility. Sidecars have nonetheless continued to be a popular means for the capital markets to gain exposure to the perceived exceptional returns on offer within US catastrophe-exposed business.

“The unfolding crisis triggered by sub-prime mortgage securitisations is a timely reminder that such products should not be viewed as a panacea

This buoyant market for innovative risk transfer to the capital markets is a significant clue to the evolution of reinsurance and retro capacity in 2008. A whole new infrastructure has indeed been created around insurance-linked securitisations. Dedicated teams within the major investment banks (and traditional reinsurers) are increasingly structuring new products and attracting capital market investors to the market.

It is difficult to see how they would fail to bring new, and possibly cheaper, capacity to the reinsurance market. Nevertheless, the unfolding crisis triggered by sub-prime mortgage securitisations is a timely reminder that such products should not be viewed as a panacea.

Highly-prized coverage

What does all this mean for the traditional retrocessional market? Although retro capacity is now much reduced from that in 2005, resulting in much firmer rates, some reinsurers have been able to purchase attractively priced traditional retro programmes for 2007 off the back of long-established business relationships. Others maintain that since traditional retro coverage does not suffer from basis risk, it will always be sought after as the long-term solution of choice for balance sheet protection.

The onus, more than ever, will be on cedants to demonstrate to reinsurers that their catastrophe modelling and exposure management in major peril zones is state-of-the-art, if they are to secure such highly-prized coverage.

The next few months will have many investors on a knife-edge. If Dean proves to be the only significant storm of the season, though, investment banks may well end up being the "topic du jour" during this year's Monte Carlo Rendez-Vous.

Paul Delbridge is a partner and Jean Bernard Crozet is an associate director in the insurance industry group at PricewaterhouseCoopers.