Given the erratic nature of global risks, any attempt to predict what 2006 might have in store for the industry verges on utter folly All the same, Helen Yates gives it a go.

Dusting off the crystal ball in an attempt to peer into the future is a difficult task in any industry, but perhaps nowhere more so than for the insurance and reinsurance industry. By its very nature an unpredictable and dynamic business, one only has to look back to 2005 for ample evidence of the unexpected. Who could have predicted the Boxing Day tsunami at the close of 2004 or the London bombings in July 2005? Who could have predicted Hurricane Katrina and the subsequent flooding of New Orleans?

(Although many claimed after the event that they had.) The point is, as we enter a new year with a vague or even a clear idea of where the industry is headed, as always, the best advice is to expect the unexpected.

STILL FEELING THE IMPACT OF 2005

One of the easiest predictions to make as we progress into 2006 is that the hurricane losses of 2005 will continue to be felt. "As with changes following the World Trade Center disaster, the market is being asked to re-evaluate, re-adjust and re-design itself," Willis observed in its recent review of the renewals. Following one of the latest and most confused renewals in history, there is still uncertainty over which direction premium rates will go across certain lines of business, an expectation of further hurricane loss announcements and a bigger question mark over what lies in store for catastrophe coverage. "As a result of the large number of catastrophes in 2005 the downward trend in the underwriting cycle has come to a temporary halt. However, we expect that if underwriting results in 2006 turn out to be very favourable the softening of rates is likely to resume," predicted AM Best's managing senior financial analyst Michael Zboron.

For Peter Middleton, managing director of Markel's Specialty Division, 2006 will continue to be a "tale of two markets", or rather, a stable or softening market for lines not impacted by storms and price strengthening for those that are. "Whilst rates in the areas directly impacted have risen dramatically ... the further away you get the less the impact has been. Hence other critical catastrophe areas worldwide have hardened marginally, but property catastrophe exposures further afield have remained flat or continued to soften and non-property reinsurances have barely been affected."

One of the trends coming out of the renewals, which could portend repercussions ahead, is reinsurers reducing their catastrophe exposures (mainly in retrocession, marine energy and US property) or withdrawing altogether. According to David Priebe, Guy Carpenter's president and CEO of UK and Europe, the events of 2005 taught us that we are contending with a much riskier world than had perhaps previously been thought. "There has been significant pricing movement, capacity withdrawals in some of these higher exposed areas of loss severity, and underwriters in the process of repositioning their portfolios to take an adjusted view of frequency and severity of risk on the property side." Whether this reduction in capacity can be met by the new wave of reinsurers in Bermuda will continue to dominate the agenda in 2006.

Another knock-on effect of last year's hurricanes will be revised rating agency measures - particularly with regards to capital adequacy - and the recalibration of the cat models in the wake of criticism levelled at them following Hurricane Katrina. The expectation is that these developments will not be felt by the industry until later in the year. "More stringent capital requirements will be necessary which will potentially results in lower ROEs," foresees Nick Bonnar, who heads up Aspen's London market specialty lines division. "Also, the 2005 and prior models were shown to have flaws so greater frequency and severity factors will be embedded thereby causing annual modelled losses to increase dramatically."

CLASS OF 2005

How the new class of Bermudan reinsurers will fare in 2006 is subject to much speculation. With the late arrival of this new capacity there has been mixed success at the 1 January renewals. According to Benfield's latest review "the new markets arrived too late to exert significant influence on 2006 renewals but their day may yet come as a counterbalance to the anticipated squeeze on capacity in the months ahead." AM Best is more reserved in its confidence. "In addition to being susceptible to low frequency high severity events ... (the) new start-ups will be challenged by increased competition from both established companies and other new start-ups. The ability of the start-ups to effectively build and retain market acceptance will only be proven over time."

Already there appears to be a split between those start-ups attached to established brands and those funded by hitherto unknown investors, particularly private equity and hedge funds. There is the understandable belief that the Amlins and Hiscoxs will fare better. There is also a belief that the Class of 2005 is an altogether different fish from the reinsurers that started up after 9/11 or Hurricane Andrew. As they evolve they are likely to move away from the traditional model, believes James Bateson, head of corporate and regulatory insurance at Norton Rose. "They're already looking to diversify away from the pure catastrophic areas of risk," he explains. "I think they will be different from the previous generation of reinsurers that emerged - they may be more diversified and they may be more widely spread geographically."

GLOBAL WARMING

Only the truly audacious could counter that the increased incidence of catastrophic climatic events around the globe is not in some way connected to the warming of the earth's atmosphere. With an even more active hurricane season predicted by the modelling agencies for 2006 the industry must brace itself once again. The potential impact will be a function of the destructiveness of this year's hurricanes, what path they take and where they make landfall. "We are witnessing record levels of Atlantic and US landfalling hurricane activity ... Based on current and projected climate signals this high activity looks set to continue through 2006," predicted Professor Mark Saunders, lead scientist at Tropical Storm Risk and head of seasonal forecasting and meteorological hazards at the Benfield Hazard Research Centre, in December. Aside from hurricanes, other parts of the world are also expected to suffer this year from natural catastrophes as they have increasingly done in recent years.

If hurricanes again make headlines in 2006, catastrophe cover is likely to be even harder to come by. In the eventuality of another Hurricane Katrina, discussions that started last year in the US on the creation of a federal natural catastrophe backstop will continue with renewed vigour.

"If another event occurs and it taxes the capital base of the industry ... and we don't see the flow of capital coming back in," predicts Guy Carpenter's Priebe, "I think there will be discussions around the creation of cat pools sponsored on a state or federal level." Ernst Csiszar, president of the Property Casualty Insurers Association of America, is vociferously for more effective insurance against catastrophic risk. He believes the creation of cat pools is inevitable. "By the year 2525, nearly 75% of all Americans are expected to live in coastal counties. As a result, the nation faces growing exposure to significant loss from these perils," he said in December in a speech to state legislators.

OTHER TOP STORIES FOR 2006

A380 launch - Premium rates in aviation reinsurance continued to soften last year and all predictions are that this will continue into 2006, bar any major losses. However the delayed launch of the 555-passenger Airbus A380 at the end of 2006 may throw a spanner into the works. This giant of the world of aviation is expected to pose significant challenges for the industry and liability limits in particular are expected to rise.

"On the face of it this could lead to capacity shortage and subsequent hardening of rates," said David Whiter, head of aviation at Aspen. "Hull values could approach and even exceed $300m while many have talked about a liability limit of $3bn. However, there are already aircraft insured for $275m, and some charter aircraft already carry over 500 passengers on holiday routes ... Couple this with the continued good experience in the airline insurance sector and it is probable that the new plane's insurance entry will be smooth rather than dramatic. Of course, should one of the first crash or be involved in a serious incident, then the picture would change dramatically."

Alternative risk transfer - In 2006 we can expect to see continuing pressure on capital, partly driven by recalibration of the cat models and more stringent rating agency requirements, but also due to limited retrocession capacity and a need to de-risk balance sheets. As a result reinsurers will increasingly look to the capital markets. "We'll see a further expansion of capital markets related solutions to support that risk and the balance sheet of reinsurance companies through insurance securitisation, through FX-based reinsurance solutions, and through side-car capital vehicles," predicts Priebe. The appetite of hedge funds is also expected to grow, although the performance of the new Bermudan reinsurers could influence this.

Contract certainty - While subjects such as finite reinsurance, Solvency II and the Reinsurance Directive, will likely play a big part in the regulation agenda for 2006, there's no doubt that D-Day has arrived for this London market issue. According to Nick Bonnar, the signs are already looking good. "Significant progress was made during the 2006 renewal season as a result of a concerted effort by both clients, brokers and underwriters to achieve 'deal now, detail now'." And Norton Rose's Bateson believes we're going to see a lot more energy and effort going into complying with the requirements as the year progresses. "I don't think anyone wants to see the regulators coming up with their own solutions - the market's really got to work together to improve matters," he added.

Islamic-compliant reinsurance - In 2006, there will be a marked interest in Islamic-compliant products in reinsurance, or re-takaful solutions.

This kicked off in January when Lloyd's insurer Creechurch announced the formation of the first Lloyd's syndicate to be managed in accordance with Islamic principles. It described the new initiative as "the culmination of extensive research ... into the new opportunities being created in the emerging markets in the Middle East, Afria and Asia". At the same time, Takaful Re announced it had been licensed to operate from the Dubai International Financial Centre, a market that is actively promoting the growth of the Islamic insurance industry in accordance with Shari'ah principles. "One of the drivers is the huge amounts of money in the Middle East at the moment - oil prices are absolutely through the roof - and there's a new awareness as far as Islamic products are concerned," said Bateson.

Pandemic influenza - Worries that avian flu (the H5N1 influenza virus) will mutate and spread to humans will continue apace in 2006. Companies will be assessing their coverage for a potential influenza pandemic, while underwriters will be quantifying what lines and regions avian flu would hit hardest. Risk Management Solutions (RMS) is currently developing an influenza pandemic model for its clients whilst the Insurance Information Institute recently estimated that a severe pandemic, similar to the 1918 pandemic - the deadliest and most infectious influenza strain to date - could cost up to $133bn.

TRIA - TRIA may have been thrown a lifeline at the end of 2005, but the whole issue of terrorism cover in the US is far from over. According to RMS, under the new TRIA terms, over 90% of the RMS modelled average annual loss would be retained by the industry. Andrew Coburn, vice president of catastrophe research at RMS, is concerned that the changes now make it more likely that TRIA will not kick in following a terrorist attack leaving insurers to absorb most of the losses. "Obviously after all of the losses that companies have sustained in 2005 ... a major terrorism loss could be painful for many insurers," he warned. "Expect insurers to start analysis of their multi-year terrorism strategy, and trying to do the math about whether they can afford to continue coverage in 2008."

EXPECT THE UNEXPECTED

These are the most likely issues the insurance and reinsurance industry could face in 2006. But it can be reasonably expected that the industry will also contend with some highly unlikely, and as yet unpredictable, events in 2006. If there is such a thing as a quiet year in this industry it seems unlikely that this will be one of them, with such a demanding stage already set. "The most unlikely thing that will happen this year is that nothing will happen," concludes David Priebe. "If there's one thing that is certain in our business it is that the unexpected will happen and in effect the most unlikely thing is that the unexpected won't happen."

- Helen Yates is deputy editor of Global Reinsurance.