Dwindling reinsurance rates may seem like bad news for reinsurers and good news for buyers, but the reality is less simple. Falling premiums are rebalancing the market, but could also result in less choice for cedants

The consensus from reinsurance brokers is that rates fell on average by between 5% and 10% at the 1 January renewals – the most important renewals date in the reinsurance calendar.

Rate increases were strictly confined to loss-hit areas such as Chile – whose February earthquake was the year’s biggest single natural catastrophe insured loss – and cost the industry $8bn.

While at first glance the rate cuts look like bad news for reinsurers and good news for buyers, some believe there are positives to be found for the whole industry in the renewals reports. Others say the rate cuts could be negative for buyers in some respects.

There can be little doubt that the price declines will disappoint reinsurers. While they cannot have expected across-the-board increases given their experiences and the indications of 2010 – despite suggestions that poor investment returns and lower reserve releases would keep a lid on decreases – the numbers serve as a stern reminder that a soft market is well on the way.

It is also true that buyers will celebrate the rate cuts. Cheaper reinsurance in today’s harsh economic environment, in which insurers are also suffering from rate falls and dwindling demand, will be welcome.

“For reinsurance buyers this was a very successful renewal period all over the world, even in catastrophe-affected areas,” says Aon Benfield chief strategy officer Bryon Ehrhart. “In places such as Chile and New Zealand, where you have had events, the effect on consumers and businesses has been limited. A lot of that has to do with the value of reinsurance. Most of that loss can be transferred into the international reinsurance market, where there has been a very small amount of price change related to those actual events.”

Hidden pitfalls

But some suggest the rate cuts could have hidden pitfalls for buyers. In its renewals report, rival broker Willis Re points out that reinsurers’ returns will dwindle as a result of the rate cuts, and that any shocks from underwriting or capital events could cause a spike in rates.

While acknowledging that falling rates are reducing reinsurers’ expected underwriting returns, Ehrhart counters that reinsurers are stronger than ever and show little sign of weakening. According to Aon Benfield, the reinsurers it works with are likely to report combined capital of $465bn for the full year of 2010, down slightly from the $470bn they had at the nine-month stage.

“From a trusted partner perspective, the partners our clients are trading with have the highest capital levels they have ever had,” he says. “Although reinsurers are doing large share buy-backs, they are generally ending the year with more capital than they started with.”

Pricing differential

One of the issues highlighted in the Willis Re report is the pricing differential between insurers and reinsurers, which, despite predictions to the contrary, is not believed to have narrowed. “As a result, primary carriers are purchasing less, particularly in casualty lines, and reinsurers are seeing reducing premium volumes,” Willis Re chief executive Peter Hearn wrote in the report.

According to Ehrhart, the 1 January renewals have at least partially redressed the balance. “We have made progress towards closing the gap on existing transactions,” he says. “The reinsurance price decreases have reflected those in the primary market, and then ceding commissions and other terms were eased to provide another 5%-10% reduction.”

As a result, reinsurance rates are at least keeping pace with, and in some cases falling faster than, the underlying insurance prices. “This means that the partnership between insurers and reinsurers has been renewed. They are in sync,” Ehrhart says.

However, business lost through differing opinions about price has yet to be regained. Several years ago, reinsurers and their customers disagreed about the potential loss ratios of certain casualty business – reinsurers expected loss experience to be worse than insurers did. As a result, insurers opted to retain the risk rather than buy reinsurance. Over time, the business has performed better than even the insurers had estimated, so they are keen to hang on to it.

Ehrhart hopes progress will also be made here. “It was a failing of the reinsurance market to serve the insurers. That is recognised and we as brokers are working with reinsurers to address that.”

While the recent renewal season may be a net positive for reinsurance buyers, it could disappoint those who welcome choice. Ehrhart believes the prospect of dwindling returns could prompt more merger activity in the reinsurance industry. “There is room for two to five more significant reinsurer mergers in 2011 and 2012,” he says. “The numbers will make that conclusion clearer, because the expected returns have again reduced. If you take 5%-10% off the top line, that tends to have a more dramatic effect on the bottom line.” GR