Do softening reinsurance rates spell a return to the pricing nadir of 1999/2000, or are reinsurers simply giving something back after two good years? asks Jason Howard.

On the back of a very profitable previous 24 months, and given the reinsurance industry’s previous track record, there were few commentators or practitioners who would have bet on the market’s discipline holding firm at the 1 January renewals. Despite much lauding of improved cycle management, the industry wilted under the inexorable pressure and softening of rates was seen in nearly every line of business. This was also despite a significant number of natural catastrophes in 2007 and a better grip on pricing due to improved analytical tools.

Reinsurers have found themselves in an awkward position as a result of the profits generated by the insurance and reinsurance sector over the past two years. They were neatly sandwiched between the softening in rates experienced by their clients, which forced those clients to look for either reduced prices or increased retentions (or both), and their own good fortunes, which have attracted the interest of new investors.

These influences have led to discounts across the board. However, on a general basis, where is the market relative to its historical cycle, and how much flexibility do reinsurers have before business starts to look unattractive? The answer to such a question is being hotly-debated, but judging by historical pricing data and adjusting this for the lower rate on lines due to increased retentions, we are still in an above-average phase of the cycle.

For the 1 January renewals a certain disparity in approach opened up between the different major reinsurance hubs, with Bermuda adopting a more aggressive approach than London to certain lines of business, property in particular. As the intermediaries looked to exploit the leverage of this dislocation, clients seemed content to engage in brinkmanship with their reinsurers, leading to a renewal of almost unprecedented lateness.

Casualty rates are falling universally as reinsurers continue their quest for diversification into uncorrelated lines of business. Furthermore, insurers are showing a tendency towards increasing retentions in this class, which acts to reduce the share available for reinsurers. The knock-on effect of these actions will play out to a slower tune than in the short-tail classes, as the development of losses work their way inexorably through the system.

Europe softens despite cats

Europe started off last year with the largest catastrophe event of 2007, Windstorm Kyrill. The storm affected northwest and central Europe, particularly Germany, causing insured losses of between $5bn and $6bn. It was followed by severe flooding in the UK in two separate events during June and July.

In part, due to the higher retentions carried by primary insurers, a trend that has been notable over the last few years, losses to reinsurers were light, and this was reflected in renewal pricing at 1 January 2008. Loss-free property programmes were down on average by 10%, with several buyers choosing to spend the savings on additional coverages, such as aggregate deals to address the frequency issue. Loss-hit programmes were either flat or marginally up, with increases of no more than 7.5% being seen in the most extreme cases.

US property comes off a high

Twelve months ago, US nationwide accounts seemed to be heading in the opposite direction from the rest of the market, with price increases common after two fraught years of major losses. This trend has now reversed, with more available capacity for both risk and catastrophe covers, and an increased appetite for the class from Bermuda. Reinsurers are also suffering the squeeze of having to pay increased commissions on proportional treaties, which themselves are seeing a softening in the original rates.

The Asian market has seen considerable interest over recent times, as many players look to position themselves in the growing economies of the future. Taking advantage of this perceived need for a local presence, clients have driven savings on risk and cat programmes of up to 20%.

The local markets continue to be bombarded by new start-up operations, with Lloyd’s syndicates putting down their marker for the first time in the region through their local licenses. As was predicted last year, the effect of the new capital invested has been felt strongly this renewal, and coupled with traditional reinsurers’ desire to protect their existing portfolios it has led to jockeying for shares on a number of programmes.

It seems hard to remember the last time the financial sector was discussed without reference to the subprime crisis and its ensuing fallout. Not wishing to buck the trend, it is worth a comment, but only to say that the renewal seemed singularly unaffected by this spectre at the feast. Issues in the credit markets have not produced any meaningful impact of the recent renewal, with most classes of business unlikely to bear the brunt of any fallout.

Whilst some losses to the asset side of the balance sheet are to be expected, plus the odd shock – as was the case with Swiss Re’s recent write-off announcement – the industry seems content to put the matter to one side until the development of the various professional lines claims are better understood.

There was some speculation that the downturn in the wider credit markets would have a negative effect of the development of capital markets’ appetite for insurance risk. However, the reverse has been the case, with cat bond issuance in 2007 at an all time high coupled with increasing demand for private placement transactions.

With the winding down of many sidecar arrangements as scheduled, the trend would seem to be that those more short-term investors that feasted on sky high prices in the immediate aftermath of hurricanes Katrina, Rita and Wilma are withdrawing, to be replaced by longer-term investors attracted by a developing asset class that is largely uncorrelated to the rest of their portfolios.

The insurance-linked securities market is likely to become an important risk transfer and capital management option for the industry, as insurers and reinsurers pay greater attention to the management of their own capital structures. With record profits juxtaposed against a softening rate environment, share buybacks are happening on a continual basis, and Lloyd’s Syndicates are reducing stamp capacities.

As an overall perspective, whilst the reinsurance market seems to have been prepared to shave off part of the profits of its underwriting activities to satisfy client demand, the industry is in good shape if it settles here. However, if there is any more subsiding of the pricing foundations, it may be time for some underpinning to take place.

Jason Howard is CEO of Willis Re International.