Jurgen Graber considers the effects of a softening market

Everybody in the market knows that the hard market might start fading, and that consequently reinsurers need to brace themselves for declining premiums, coupled with less favourable terms and conditions. In short, less income for more risk. Since it is common knowledge that weak markets tread on the heels of hard markets, it could be argued that there is nothing new; it is just the well-known cycle. It could well be expected from a reinsurer that they have learnt their lesson in former cycles and know exactly how to adjust their underwriting strategy.

Our answer is: yes, we believe in an ongoing rotation of reinsurance markets. However, from one cycle to the next, a lot of other changes incessantly influence the nature of the business and hence the subsequent market phase.

Since we entered into the last soft market - nine or ten years ago - the way of dealing with some lines of business has dramatically changed. This change is most conspicuous if we look at catastrophe business. Risk modeling has created transparency in the evaluation process of catastrophe scenarios.

Prices for catastrophe covers, which ten years ago were still quite often merely determined by the rules of supply and demand, nowadays vary only within the span worked out by the various models existing in the market.

Probabilistic methods still lead to a marked variance of risk evaluations, not because the methods are bad but because the amount of data they need is huge, and because needed data are not always available or not always sufficiently accurate. However, it is clear that prices are distinctly less elastic than they were ten years ago. The effect on the cyclicity in this instance is obvious. We will no longer experience sharp ups and downs as we did in the past. There is a certain safeguard against insufficient prices. There is, however, also a threat for reinsurers - and insurers alike - that risks are transferred directly to capital markets by way of securitisations. Those reinsurers that have gained experience in securitisations, right from the beginning in 1994, certainly enjoy an advantage, be it for their own risk disposal or be it that they act as a facilitator. Reinsurance expertise is still highly welcome in a securitisation process.

The transformation of natural catastrophe business may suffice to illustrate that cyclicity does not mean a mere repetition of market conditions. Cycles are rather a reiterating pattern, a pulsating rhythm in the incessant evolution of our market. Thus, it is obvious that in each cycle reinsurers face new challenges. Their strategies have to be different from the last weak market phase.

Where exactly do we find ourselves in the changeover process from a hard to a weak market? Let me first briefly outline how I perceive the sequence of transitions, the basic pattern of reinsurance cycles. The first line of business to indicate a hardening market is property, starting with natural catastrophe covers, followed by per risk covers. With a certain delay, prices for casualty covers show a tendency to increase, followed by an inherent improvement of reinsurance conditions on the casualty side.

When the market softens, property is the first indicator, followed by a decline in casualty prices, and finally by an extension of cover given, i.e. increased risk transfer, on the casualty side. The actual situation of the market is that casualty prices are now levelling off.

Before elaborating on how reinsurers ought to adjust their strategies, another new feature of our market conditions has to be highlighted. The financial situation of reinsurers is by far more transparent than ever before. Rating agencies are closely watching the financial strength of market players and their ability to produce a commensurate return on equity, and they publish their findings. No market participant can any longer afford to try and survive weak market conditions by allowing inadequate returns on equity, in the hope that it will be rewarded by an expanded market share in the next hard market phase. Yet we observe more and less aggressive market players. The difference results from their reserving methodologies. There is no doubt that all of our peers follow best actuarial practices. It is a fact, however, that the adequacy of reserves can be assessed more or less conservatively based on loss cost trend factors.

Whenever a company decides to be more conservative, this will hardly be noted by rating agencies, and hardly any credit will be given for it.

What is now Hannover Re's strategy for surviving the soft market and still producing the required return on equity; what is the company going to do differently? First of all, it is deeply rooted in the minds of the company's underwriters that "volume is vanity, profit is sanity". There will be an ongoing emphasis on special casualty business; proportional property will be written on an even more selective basis. The company has always had a niche focus, and this will be further enforced. In the US, the approach towards surplus lines business will become even more conservative; commodity business will tend to be reduced.

Hannover Re is close to the worldwide community of mutual companies, given its background as a subsidiary of Germany's biggest mutual insurance company, Talanx AG, and its close links to other German mutuals via its own subsidiary, E+S Ruck. Mutuals are an important target client group, though Hannover Re appreciates that this has never been misunderstood as an exclusive orientation. A loyal and stable client base worldwide is considered to be of great value for the company. It is even more than that; it is the sound basis for success in a weak market.

As a reinsurer, Hannover Re feels as committed as all others to balancing highly volatile business worldwide, but it aims to ride the cycles more effectively, to try to be slightly ahead. In addition, Hannover Re's positive relations with brokers are considered to be a valuable asset.

For the whole industry it will be of crucial importance not to lose too much money when the market is at its bottom. After the failures we have unfortunately experienced in recent years, and problems in recent months, there are signs that discipline in the market is noticeably better than at the beginning of the last soft market phase. This gives us hope that the industry's target can be achieved.