Mark Hewett argues that taming the reinsurance cycle is more feasible now than ever before.

The cyclical nature of the reinsurance industry is reflective of the ebb and flow of capital in a competitive marketplace. Individual companies assess the risks, set their prices and allocate their capital according to how they perceive market conditions. But while an integral part of the sector’s makeup, the volatility of the peaks and troughs experienced in recent years has been little short of disastrous for participants. One need only examine the average return on equity generated by the property and casualty sector in recent years to see how the extremities of the cycle have hindered the market and depressed returns to, arguably, an unacceptable level.

The volatility of the reinsurance cycle is not there by design, but rather serves starkly to reveal the failures in some of the processes which have historically been central to the way this industry operates. In recent years, however, a combination of a more sophisticated approach to pricing and more effective analytical tools, coupled with the external influence of the capital markets and the regulatory authorities, have served to create an opportunity to establish greater control over the cycle.

The insurance and reinsurance industry today operates in a more sophisticated pricing environment, which is founded upon a greater understanding of the risks being taken. The risk modelling environment is also more robust, allowing companies to better assess their overall risk profile relative to the capital required to support it, and furthermore to ascertain the potential returns from their risk portfolio more accurately.

These factors have resulted in a more comprehensive approach to the analysis of information which in turn has facilitated greater accuracy and transparency in how the industry prices the risks and an overall improvement in underwriting practices, both of which serve to dampen the reinsurance cycle.

“The volatility of the peaks and troughs experienced in recent years has been little short of disastrous for participants

Mark Hewett Chairman of Guy Carpenter & Company Ltd

A further contributory factor in pricing discipline is the changing nature of the capital markets. Capital is much more mobile than it was ten years ago, and can quickly enter the market in the aftermath of a major catastrophe to regenerate capacity. One need only compare the speed with which the market was able to recapitalise in the months after the World Trade Center tragedy and Hurricane Katrina, to that of Hurricane Andrew.

The role played by enterprise risk management (ERM) should also be acknowledged for its positive effect on reducing the volatility of the reinsurance cycle. Numerous ERM-related initiatives, particularly in the UK and Continental Europe, are forcing industry participants to conduct more detailed assessments of how they deploy their capital. As a result, we are witnessing a more rational approach to underwriting practices and pricing procedures, as companies seek to manage their risk profiles and their overall market share.

The nature of the industry in which we operate means that we will never fully eliminate the reinsurance cycle. However, the market is now in a position where it has sufficient tools and checks in place to tame its severity. Better pricing discipline based upon improved risk assessment may, and should, serve to instil a greater level of stability to the reinsurance cycle to the benefit of all participants.