Dire predictions for the industry a year ago have been largely disproved as reinsurers kickstart 2007 boasting massive profits. So is the outlook more upbeat now? Asks Lindsey Rogerson.
"What a difference a year makes" is how Benfield chose to open its market outlook for 2007. Indeed. Flick back 12 months and the brokers, along with the analysts, were decidedly more downbeat about the prospects for reinsurance rates - and consequently for reinsurance profits - in 2006, than were the reinsurers, themselves.
It turns out the reinsurers were right. So what is the broker market predicting for 2007? Commentators are a little more upbeat than last year, but statements are still littered with qualifying phrases. Those of Peter Hearn, chief executive of Willis Re, are pretty typical. He said: "The twin blessing of fewer losses and more capital combine to make the 2007 reinsurance renewal season, for most insurers, less costly."
Of course all such comments should be taken with a large pinch of salt. Brokers have a vested interest in taking rates down for their primary insurance clients. Looking at the evidence of renewals declared so far: Hannover Re said it had turned to the capital markets to boost its catastrophe capacity; and as figure 1 shows, while non-US cat rates may have lost some of their recent gains, US catastrophe rates are up by more than 40% this January.
Willis confirms this pattern of the sliding of flat non-US rates. It reports across the board slides in European catastrophe rates (except those with wind exposed risks), Australia, Latin America and Asia of 5% to 10%. However Hearn agrees with the 40% US East Coast and Gulf Coast hike.
Glass half full
Alec Foster, fund manager of the Hiscox Insurance Portfolio Fund is confident that reinsurers will be able to negotiate their way around rate fluctuations and is consequently decidedly more positive on the outlook for reinsurance companies. Indeed, so positive is Foster on reinsurance groups that they now make up one quarter of his fund. He explains: "Catastrophe reinsurance rates in the US are still at high levels with little sign of easing. The 1 January renewals are playing catch-up on the prices charged in the second half of 2006. Non-catastrophe classes generally have begun to ease from a high level and rates are flat to down a bit. It's neither dramatic, nor steep. Terms and conditions are holding firm, which is much more important. In short, pricing is capable of maintaining strong earnings growth."
Foster is also encouraged by reinsurers' increasing willingness to share some of their spoils with their investors. He said that while capital has historically been squandered, a number of the funds' holdings have announced increased repurchase authorisations in recent months. "Capital unutilised is now returned to shareholders," he notes.
Such willingness to share profits is helping to fuel interest from investors. Foster said he expects to see further releases from reserves in 2007 and that the possible peak in interest rate cycles in the UK, Europe and US will also help increase the sector's attractiveness. "Insurers principally invest in bonds with a short duration," he said. "With more money invested and less claims from the recent underwriting years, there is more cash at work too. The new capital raised, in the form of sidecars and other ventures, has come from sophisticated and successful investors (not only in insurance) and should not represent a risk to pricing."
Benfield's review of 2007 renewals "Pick 'n' Mix" is equally confident that the influx of new capital (see figure 2) will not have a detrimental effect on prices. The report said: "Despite the rapid growth of the catastrophe bond and sidecar market, the amount of capital raised in 2006 represents only 3% of the estimated $330bn capital of the global reinsurance market." The broker is uncertain whether new investors will remain in the market long term. Although their exit - should it happen - is not necessarily viewed as a bad thing, Benfield seeks to remind the industry that the reduction in the "underwriting cycle's amplitude has long been seen as the holy grail of the industry."
Catastrophe loans and bonds have by their very nature a shorter shelf life than fully-fledged reinsurance businesses, and sidecars can also be more easily retired, which of course would make more business available to traditional vehicles. This flexibility would tend to bode well for reinsurance returns - because it means that should the providers of this new money (for the most part provided by investment banks, hedge funds and private equity firms) no longer feel they are making superior returns they could simply pull the plug and pursue investment returns elsewhere.
Rain or shine
Finally there is one more crucial - unpredictable - element to the ongoing health and attractiveness of reinsurance companies ... the weather. Forecasters think it is highly unlikely that 2007 will be as calm as 2006. Even the most powerful man on the planet, George W Bush, has accepted that global warming is a reality. Experts believe its impact on weather patterns and climate is no longer theoretical and that in the southern hemisphere, El Nino is building up once more.
In its renewals report Benfield warns: "Many see no reason to suppose that the upward trends in frequency and magnitude of insured catastrophe losses will change. And it is always earthquake season." This analysis, if proved correct, would of course prove business generative and profitable for well-managed reinsurance books. Hiscox's Foster believes that a further reminder this year from Mother Nature that we are living in a much riskier world might, in the long run, be beneficial for the industry. "It's extremely unlikely that we will have windless year," he predicts. "Losses concentrate the mind and in a world with ever-increasing levels of risk and uncertainty the need for insurance is likely to grow rather than decline."
- Lindsey Rogerson is a freelance journalist.