Lee Coppack looks at the forces shaping property catastrophe reinsurance since Hurricane Andrew.
A devastating loss followed by the formation of heavily capitalised new companies in Bermuda, forecasts of gaping holes in property catastrophe reinsurance - it looked like the aftermath of Hurricane Andrew all over again. But ten months after the World Trade Center (WTC) disaster, there are some fundamental differences.
Today, instead of the capacity shortages and sharp rise in prices that followed Hurricane Andrew in 1992 but peaked only two years later, the prediction is for a comparatively stable global market in this most volatile of risks. Capacity is not a problem at the right price, and price increases are generally not extreme. Reinsurers are much more confident in their ability to price the risks and control their aggregations than after Hurricane Andrew. At the same time, falling investment income and asset values are focussing attention on underwriting results.
As with Hurricane Andrew, the WTC loss was the climax of a series of moderately severe losses, and, perhaps more significantly, growing concern about the level of reserves for exposures like asbestosis-related disease. When capital in the re/insurance industry shrinks, it triggers a hard market, said economist David Durbin, head of product and risk management for property/casualty reinsurance at Swiss Re. "This has now happened. Capital in the industry shrank in 2000 and 2001 as a result of equity markets and big losses. For this to happen two years in a row is exceptional over the last 40 to 50 years."
It looks like the process is continuing, although good results in 2002 should bolster balance sheets in 2003, absent a major catastrophe. In July 2002, Munich Re added $2bn to American Re reserves and $500m to its provisions for WTC. Donald Watson, managing director of the Standard & Poor's (S&P) insurance rating group in New York, says asbestos remains a problem and claims from toxic mould are coming into commercial lines. "There are plenty of clouds on the horizon."
Capital shrinkage is occurring on both sides of the balance sheet. Many re/insurers are having to write down the value of equities and corporate bonds, and few believe interest rates will fall further; if they rise, the value of reinsurers' fixed income portfolios will drop.
Once capital has left the industry, said Mr Durbin, more comes in with the expectation of better results. This was certainly the case in the fourth quarter of 2001 and into 2002. After Hurricane Andrew, eight dedicated property-catastrophe companies were set up in Bermuda; in similar fashion, about $14bn in new equity and debt was raised in Bermuda after the WTC disaster, albeit faster than post-Andrew. Other new capital has come into the US, notably from AIG, and Lloyd's and the London market. In mid-2002, the Lloyd's agency Wellington Underwriting successfully launched a £448m ($700m) new UK reinsurance company, Wellington Re. Continental reinsurers, Hannover Re and SCOR, and Lloyd's agency Hiscox have tapped financial markets with catastrophe bonds.
However, the capital that has left the market - estimated at around $100m - still is substantially exceeded by the new capital, more like $35bn. S&P retains a negative outlook for the property/casualty market, believing that it is likely to need to downgrade some ratings further, and the uneasy state of the stock market mid-year was having an inhibiting effect. In July, "due to current capital market conditions," the St Paul Cos postponed the initial public offering of Platinum Underwriters Holdings, Ltd, the Bermuda-based company that will acquire its continuing reinsurance.
There is a clear consensus: there may be a few constraints but there is enough capacity for natural catastrophe risks. This was not the case after Hurricane Andrew.
"Today," said James Bryce, president and CEO of IPCRe in Bermuda, "there is plenty of capacity at security of A- and better. It may be a bit more difficult if companies will only settle for A or better but that is all. This manifests itself not in differential pricing but in signings. A- rated reinsurers may find they do not get as much of the more desirable programmes as they would like," he commented.
"There is no problem," said Pierre-Denis Champvillard, senior vice president of SCOR. At the 1 April renewals, the Japanese market was able to get probable maximum loss limits (PMLs) of $15bn as it had before. Globally, he said, there is capacity for PMLs of $15bn-20bn.
David Spiller, managing director of broker Benfield Group, said the 1987 UK windstorm, designated 87J, and European winter windstorms of 1990, had already drawn attention to the weaknesses in data quality. In the immediate aftermath of Hurricane Andrew, it was almost impossible to place property catastrophe reinsurance "at any price", because the storm had demonstrated even more forcefully the huge gaps in the monitoring of aggregate exposures. "The reinsurers just could not take the uncertainty," he said. "Now they are more comfortable that they understand the underlying exposures."
The broker EW Blanch, now part of Benfield, and Applied Insurance Research launched the first commercially-available hurricane models in 1987. The concentration of exposures revealed by Hurricane Andrew and the explosion in computing power in the intervening period meant that the new Bermuda property catastrophe reinsurers embraced the concept of catastrophe modelling with alacrity. In the ten years since, the models have been almost constantly refined and extended. (For more on the development of modelling, see p4).
A serious review of reinsurance practices followed Hurricane Andrew, said Bruno Meyenhofer, CEO of PartnerRe Global, the largest of the original property catastrophe reinsurers. It led to a much more rigorous approach to risk and the management of capital, supported by an injection of discipline by financial markets. However, he added, "While Andrew was a catalyst to bring change, significant additional forces shaped the market: globalisation, investor preference for focus, fascination of size (top five or else) and so on."
These factors have created a terrific consolidation in the reinsurance market. Since 1990, the non-life reinsurance market overall has become a great deal more concentrated. The Association of French Reinsurers (ARF) estimated that in 2000, the top five reinsurance groups had 51% of global property/casualty business and the top 20 controlled 80% of the market. In 1990, the top five had a market share of 21% and the top 20 had 39%. The number of members of the Reinsurance Association of American (RAA) has fallen to 19 in 2002 from a peak of 32 in 1988, the lowest number for at least the last 20 years.
Spotlight on underwriting
US catastrophe XL rates had begun to firm in 1990 following Hurricane Hugo. By July 1994, post-Hurricane Andrew and the Northridge, California earthquake, they had more than doubled their 1990 level, according to the US catastrophe rate index maintained by Benfield Group subsidiary Paragon Reinsurance Risk Management Services. By January 1995, rates were falling and continued to fall until the July 2000 renewals (Table 1.)
The stock market, on the other hand, was buoyant. The US Standard & Poor's 500 stock market index was climbing in 1992 and continued to do so until July 2001. Long dated fixed interest securities bought in the high interest days of the mid-1980s plumped out asset values. Consolidation and regrouping was the order of the day in the international reinsurance market, and the years from 1996 to 2000 were comparatively light in natural catastrophes. It all fuelled competition.
Swiss Re estimates that catastrophe XL premiums increased about 25% globally in 2001 and are rising a further 26-27% in 2002, back to around the peak level of the 1993-1994, said Mr Durbin. This is far less dramatic, and so more palatable to insurers, than the state of the market following Hurricane Andrew. In the US, the Paragon index showed an increase for the first time since the early 1990s with the January 2001 renewals.
Reinsurers are positive about rating trends. Said IPCRe's Mr Bryce, "The market isn't so much hard as hardening. Everyone is using models and if the programme is below the trigger price, the reinsurers are not interested."
The cushion which reinsurers have used to soften underwriting losses will now be significantly flatter. In a low interest rate environment, investment income from fixed income portfolios will reduce as older, higher yielding paper is replaced. Mr Watson explained that underwriting ratios which produced a profit for reinsurers when yields were around 7.5% to 8% will no longer do so. As a result, he now believes that reinsurance rates are likely to continue to harden into 2003, and improvements in primary rates will feed through to reinsurers through proportional treaties.
The technical approach to underwriting combined with concentration of the market in the hands of big players, has created a sense of a community of equals when it comes to pricing. SCOR's Mr Champvillard remarked "Nowadays there is a kind of consensus as to what levels are acceptable in terms of pricing."
A similar view comes from Larry Tyler, account manager, property treaties for Alea in London. He said the days are gone when a leader set the rate and capacity just followed. "Today, we look at most programmes as a panel, so there is a consensus."
However, one consequence of this more rigorous approach to underwriting is that while it can justify price increases, it can also allow cedants to argue that there is no technical evidence for real increases to their premiums if the risks have not changed.
Sean Mooney, chief economist at Guy Carpenter, argued that of all the lines of business, property catastrophe is the most competitive. He observed that in the US, the rate of increase in cat prices had slowed in the 1 July renewals, and some companies were paying no more than last year. "The market is very technical. All reinsurers are using models and if there is no underlying exposure change, it is hard for the reinsurer to say that the technical rate should be higher."
In the London market, Larry Tyler also noted that on US programmes unaffected by WTC claims, the increases have been "fairly modest - which is disappointing." However, he observed that in other territories unaffected by WTC, such as the Caribbean, original rates had increased after September.
In Europe, the 1999 winter storms Anatol, Lothar and Martin had already pushed reinsurers into corrections, SCOR's Mr Champvillard emphasised that reinsurers are also exposed to catastrophes through proportional property treaties. SCOR is pressing strongly for considerable improvements to pro rata contracts where it believes that the price is not adequate for the natural catastrophe element. "Traditionally," he said, "most cedants look for technical results of zero over the long term, but this does not pay for the cost of our capital. We need a technical profit to manage the cost of the catastrophe element, which includes some large natural losses. The battle started last year and is continuing."
Support for this view comes from Partner Re Global's Mr Meyenhofer. He said what is known as dollar swapping business might stabilise the combined ratio, but does nothing much for the bottom line. "As any kind of premium is counted against capital, the disappearance of dollar swapping premium may well increase the true risk-carrying capacity of reinsurers," he commented.
Arno Junke, head of German non-life business for GeneralCologne Re, said reinsurers will be looking for further increases from German cedants for two reasons. The first is a high frequency of small to medium-sized catastrophes, such as hail-storms and regional flooding. The second is to cover poorly defined exposures, unless there is improved transparency from cedants.
"We told clients earlier this year," he said, "that there will be a lot of higher prices for cat capacity where clients say they cannot respond. We have even talked about event and annual catastrophe limits on pro rata treaties." The drive for better risk information is a common theme, with growing pressure for ceding companies to use the global reporting standard, CRESTAplus. (For a longer discussion of CRESTAplus, see p24).
"We may see some further hardening," said Mr Champvillard. "The increases have not been uniform and if we have a big loss, they will be affected."
About $14bn of the new capital raised since September is in Bermuda, although some of it was already in the pipeline. Existing Bermuda re/insurers contributed about 30%, while new names and established investors in Bermuda created companies that were immediately in a position to write very substantial lines - up to $100m - on catastrophe programmes.
Among the established backers are AIG, Marsh & McLennan, Chubb Corp, Zurich Financial Services and Goldman Sachs, with large investments in Allied World Assurance Co (AWAC) and Endurance Speciality Insurance. In addition, New Hampshire insurance company, White Mountains, has capitalised Montpelier Reinsurance at $1bn. Another $1bn company is Arch Capital Group. Leucadia National Corp and Gilbert Global Equity Partners are behind the $500m company Olympus Reinsurance, and the giant US mutual State Farm is one of the founders of the $500m DaVinci Reinsurance.
Softening of property catastrophe rates so soon after Hurricane Andrew led to reshaping of Bermuda's fledgling market. Considerable amounts of capital were returned to original investors in dividends and stock buy-backs to take advantage of buoyant stock market conditions. Today, only three of the eight original property-catastrophe specialists remain independent, Renaissance Re, IPCRe and PartnerRe. PartnerRe has developed into a multi-line reinsurer and is now one of the largest in the world.
Against this background, the business plans of the new companies are much more varied from the start. GoshawK Reinsurance is a catastrophe, XL and retrocession writer, but others have not constrained themselves to anything more than property/casualty insurance and reinsurance. A shortage of suitably rated US property/catastrophe reinsurance is already turning their attention to other territories and other classes. As S&P's Mr Watson pointed out, "If you have got $1bn, it needs a lot of premium to support." And the companies' sponsors have set ambitious return targets.
AXIS Specialty, the vehicle formed by Marsh & McLennan's MMC Capital, is the largest of the new companies with $1.6bn in capital. It moved quickly to be in a position to write admitted US business by buying two US insurer shell companies, Royal & SunAlliance Personal Insurance Co and Connecticut Specialty Reinsurance Co, in March 2002. Renamed Axis Specialty Reinsurance Co and Axis Specialty Insurance Co, respectively, they give Axis an entry into all 50 states.
Endurance Specialty Insurance Ltd., a $1.2bn new company backed by Aon and Zurich Financial Services Group, has bought the business in force of LaSalle Re, one of the original property cat underwriters from the US insurance group Trenwick which had acquired the company only two years previously.
Meanwhile, Bermuda continues to generate new business models. A shortage of physical space and `wet ware', meaning qualified staff on the island, has some of the new capital providers opting to use the services of the two dedicated property catastrophe reinsurers, Renaissance Re and IPCRe, to manage their business.
IPC has close links with AIG and writes for AWAC, the $1.5bn property/casualty company set up by AIG, Chubb and Goldman Sachs. Renaissance Re has a growing stable of catastrophe-related reinsurance companies operated in partnership with other insurers, including DaVinci Re, one of the first new companies to be formed after September 11. Renaissance Re was already managing Top Layer Reinsurance, another joint venture with State Farm.
Rather than employ separate management and underwriting teams for each of its ventures, Renaissance Re allocates transactions to each facility as they arise. "The results of the allocation process are audited to ensure fairness," said James Stanard, chairman and CEO of Renaissance Re. "As it turns out, so far each of the pools has achieved slightly better results for its shareholders than our own pool has."
A healthy market
Bruno Meyenhofer said that the WTC tragedy seemed to demonstrate several things:
Broker David Spiller drew an important contrast between 1992 and 2002. "The dynamics are fundamentally different. After Hurricane Andrew and other losses, there were quite a lot of failures in the US and London. This time, even though reinsurers have lost a lot of money, the losses are being paid. The market is trading forward and providing capacity given proper pricing. I think reinsurers have responded remarkably well."
Mr Meyenhofer concluded, "Even the difficulties we always experience as an industry at the `crunch end' of a cycle cannot obscure the fact that our industry has managed to shoulder over a long period an ever-increasing burden of exposures and claims. In my opinion, it will (as an industry) continue to do so."
By Lee Coppack
Lee Coppack is a writer and analyst on re/insurance and risk management topics. She is guest editor of this edition of Global Reinsurance. Email: firstname.lastname@example.org