Does the 2007 renewal season represent a return to normality or is this the tipping point in the cycle? David Pannell examines some of the key trends.

After the excitement of the last few years, this was an exceedingly orderly, if late, renewal season. Willis Re's top line view is that property and casualty rates were generally flat or have softened. The significant exception to this was US property with catastrophe wind exposure - notably on the East Coast and Gulf Coast. In addition, retrocession remains a difficult market with a shortage of supply.

One of the most interesting questions arising from the 2007 renewals season is what it indicates about the state of the industry? Overall it is in pretty good shape - indeed the best it has been in for several years.

As good as it gets

Buyers and sellers of reinsurance went into the 2007 renewal season in excellent condition. For reinsurers' balance sheets, 2006 looks like being one of the best years ever for the industry. The lack of catastrophe losses combined with robust pricing translated into strong earnings. All of these factors, along with evidence that the cycle of rating agency downgrades has begun to turn, instilled a sense of confidence across much of the reinsurance industry.

The entry of new capital also helped to create an orderly renewal season by reducing previous disparities between supply and demand. New capital entering the industry included that raised by the Bermudian Class of 2005 and the increasingly important non-traditional sources of capital. These include sidecars and catastrophe bonds, with issuance of the latter doubling in 2006 to over $4bn. The total contribution of non-traditional capital reached 6%, according to Goldman Sachs, which represents a small but critical component of reinsurance supply.

As a result of all of these factors, demand and supply were more closely aligned than they have been for a few years. Indeed many commentators expressed the view that the market felt as if it had almost returned to normality.

Despite these positive factors, reinsurers generally remained cautious. The losses of 2004 and 2005 remain uppermost in underwriters' minds. In practice, this meant underwriting discipline was maintained, with only localised evidence of market share becoming a driving factor. One of the reasons for this is the ever growing importance of modelling and analytics. The results of these exercises were an important factor in determining the corridor for final agreed prices.

Pricing changes in the US reflected the perception of increased volatility that is embedded in the latest property catastrophe models. As a result, there was greater interest in international property, such as Scandinavia and the Middle East, which is seen as diversifying away from US catastrophe exposure. The desire for diversification is being driven by a number of factors, notably the methodologies used by the rating agencies. Diversification was one of the main causes of softening in the casualty market as reinsurers shifted capital from property lines.

Few changes in Europe

European and Asian property and casualty rates are illustrative of the general market. Generally, there were no significant movements with most changes in the range of between minus 5% to minus 10% for loss free accounts (see figure 1).

In the UK, property risk loss free rates were down by 5% to 15% and catastrophe loss free rates were flat to down 7.5%. Overall, this means Willis Re's UK property catastrophe pricing index continues to slide after its most recent peak in 2003 (see figure 2). In other parts of Europe there were some notable movements. For example, French motor excess-of-loss rates rose between 15% and 30%, after the well publicised rise in claims. In Germany, risk loss hit property rates were up by 10% to 20%.

Mostly quiet in Asia

The Asian market generally reflected global trends. Australian property experienced no shortage of capacity, with brokers reporting significant catastrophe lines being offered. There were improved terms available for pro rata. Casualty rates across Asia changed modestly - generally within the range of +5% and -5%. Rate rises were slightly higher for loss hit renewals. Taiwanese risk loss free rates fell by between 10% and 20%, following the Advanced Semiconductor Engineering fire-related increases in 2005.

There was increased interest in Asia from reinsurers, such as some Lloyd's syndicates. In addition, the new capacity being provided by Asia Capital Re and China Re Group demonstrates the growing importance of the region. Although this was not significantly influential at this renewal season, it will have an impact in the future.

The US exception

The major exception to the global trend is US property business. This market continues to fragment with each segment exhibiting peculiar dynamics and hence pricing trends. On the one hand are nationwide and/or critical catastrophe accounts. In these cases reinsurers sought to bring their pricing in line with the mid-year 2006 levels. Although the market generally fell short of this goal, cedants still experienced sharp rate increases. These are estimated to average 40% on a risk-adjusted basis, which factors in higher deductables.

A further market dynamic was the growing importance of the Northeast Coast. Reinsurers and their investors now have a new appreciation for the insured values and the resulting catastrophe exposures of this region and hence prices rose. We have now termed this the third "peak zone", alongside Gulf windstorm and Californian earthquake.

By contrast, regional business did not generally follow the trends of the nationwide accounts. Programme structures were very similar to those expiring. Pricing only shifted materially upwards on some midwest accounts that suffered losses during 2006.

Retro still scarce

Retrocession capacity has been an issue for a number of years. At the 2007 renewals it remained a problem, despite the growing importance of non-traditional capital coming into the sector. Goldman Sachs now estimates that 30% to 40% of retrocession is now provided via securitisation. However, despite this contribution capacity shortages remain. This shortage was reflected in another steep rise in rates at 1/1. Willis Re's index of retrocession pricing trends shows that rates have risen an incredible 217% since 2000, and nearly 60% since 2005.

All eyes on Florida

While the 2007 renewal season was largely straightforward, the ability of the reinsurance industry to surprise is a constant. This is most clearly demonstrated by the recent announcement of the Florida House and Senate agreeing legislation that expands the Florida Hurricane Catastrophe Fund (FHCF). The impact of this is akin to the creation of a new $38bn capitalised Florida reinsurer. Willis Re estimates this could result in as much as $1.2bn of lost excess premiums to the reinsurance market. The FHCF decision means reinsurers must rebalance their portfolios. In practice, this could lead to reinsurers seeking to increase their income from products and regions outside Florida, which could have a major impact on pricing at renewals later this year.

- David Pannell is part of Willis Re Research.