There are two camps where the casualty sector is concerned. One believes rates will continue to spiral downwards, while the other is ever-hopeful of a pricing correction. Will Roberts reports.

Following on from a year of healthy profits in 2006, the casualty sector continues to enjoy a buoyant year in the face of heightened competition and a softening market. Will it stay that way?

The current state of play in the sector is positive. "It has been very profitable in the last two years," says Mark Rouck, a senior director at Fitch Ratings. "Rates hardened in 2004 and these more favourable premiums have now worked their way through to companies' earnings... In addition, there has been a decline in the litigation aspect of the casualty sector, resulting in good profits."

Graeme Brydon, European casualty manager at Liberty International, agrees. "The casualty industry is relatively buoyant at present, with the market declaring good profits." These profits have been delivered in the face of growing competition. "We're continuing to see a competitive environment, with new players having a significant impact," he added.

The push to diversify for a number of monoline property catastrophe reinsurers was given a boost in 2007. A large number of reinsurers enjoyed record earnings in 2006 on the back of a benign hurricane season and this excess capital, says Brydon, has funded many new casualty ventures. "When a company has excess capital, it is a logical step up to broaden your lines of business by diversifying."

Diversification also offers lucrative rewards. "Property insurers are diversifying into casualty because they are recording good profits, but also because they have seen how well those diversified reinsurers have performed," says Rouke.

Alan Bennett, managing director of the casualty team at Heath Lambert, draws attention to another benefit: "It is sensible for a monoline property insurer to write casualty from a ratings perspective. Companies who have been downgraded have invariably been monoline industries."

So are reinsurers more inclined to diversify into casualty, as supposed to other sectors such as aviation? "I don't know if they are more predisposed to diversify into casualty, but casualty offers a more pure form of diversification," says Rouke. "My sense is that going into aviation is harder because it is more specialised. Casualty exposes you to different, broader factors."

He points out, however, that with so many companies, combining property with casualty, it is often hard to assess the relative strengths of the two sectors - especially as both have been so profitable. The addition of new players to the casualty sector has increased competition, which in turn has led to a softening market and downward pressure on rates.

Subprime impact

“The addition of new players to the casualty sector has increased competition, which in turn has led to a softening market and downward pressure on rates

While competition is set to increase, industry experts expect the softening of prices to slow down. The current crisis in the subprime market is considered a major driver. "The potent impact from exposure to subprime losses and the subsequent decline in the stock markets means that casualty reinsurers can no longer rely on their investment portfolios. This may lead to a slowdown in rate decreases. Management will need to focus on rate adequacy," says Brydon.

Rouke agrees that conditions in the subprime market could spill over to the casualty sector. "If the current subprime crisis results in heightened legal liability and loss activity, then this could lead to rate increases."

Hurricane Dean, despite leading to relatively low insured losses, could once again renew the industry's focus on diversification. EQECAT estimates that Dean will cost in the region of $2bn. "Hurricane Dean brings the focus back to the need for property cat businesses to diversify," says Brydon. If so, the competition in the casualty sector could be increased further.

Rouke thinks such a scenario is unlikely. "Hurricane Dean will have no knock-on effect on the casualty industy," he insists. "Property cat reinsurers will not change their behaviour until they get seriously hurt." This view is echoed by Bennett. "Only if a cataclysmic event occurs would capital flee to other sectors. Dean was not a cataclysmic event."

Room for optimism

Over the coming year, most experts predict a continuing competitive market - but with scope for improvement in terms of rates. "The next year offers the potential for a slowdown in rate decreases - a reflection that management is now looking at all of these background issues such as the subprime market and the UK floods," said Brydon.

Bennett is less optimistic. "In terms of where the market is heading, I see it bottoming and then bouncing along the bottom." He points out, however, that should there be a significant industry loss then the whole process would be reversed, with rates again rising. Such is the cyclical nature of the reinsurance market.

Will Roberts is a reporter on Global Reinsurance.