Some Dislocation ExpectedAs Reinsurers Rewrite Books

London Editor

Will the current market hardening lead to a major dislocationand withdrawal of reinsurance capacity? Will there be a return tothe hard market of the 1980s, when coverage in some lines was nextto impossible to buy, at any price? Opinions among underwriters,brokers and analysts vary.

Thomas Mahoney, managing director for St. Paul Re in London,believes there could be a major market dislocation.

“You have companies that have bad results because of a softmarket, then theyve got some surprises in the form of prior-yearloss development that wasnt really anticipated,” Mr. Mahoney toldNational Underwriter. “Theyve been eating into theirreserves over a long period of time and writing under-pricedbusiness.”

He noted that many companies have bought various types of finitecoverages or funded spread-loss programs, which make the resultslook better than they actually are. (He said that St. Paul alsouses such products, but points it out on the company balance sheet,unlike other insurers that do not.)

Company managers will react to this combination of negativefactors by “getting the prices up and tightening up on theunderwriting terms and conditions,” he said. “The strong companiesare not going to go bust, but they know that theyve dug some hugeholes, and if youre a strong company and you want to stay a strongcompany, you have to quickly put your balance sheet back in a veryhealthy state.”

He said he is concerned that a major market dislocation would“chase more insurers and insureds into captives or self-insuredretention vehicles or funded vehicles.”

William Adamson, CNA Res chief executive officer, agreed thatthere could be some major market dislocations as a result ofprior-year losses and a long period of underpricing. “The resultsfor 1998 and 1999 are very bad” for business across-the-board, hesaid. “I think were going to see continued adverse development fromthe market,” which will drive a tightening, he continued.

“If the results are as bad as people are saying, youre going tosee more and more people re-underwrite their portfolios, whichcauses dislocation,” he said. (CNA Re is looking for a buyer forits London subsidiary, CNA Reinsurance Company Ltd., which recentlywas downgraded by Standard & Poors from a single-A rating totriple-B.)

“It is hard to predict to what degree [dislocation will takeplace] at this point,” Mr. Adamson said, given the fact that thereis still a lot of capital in the business. “But I think it willcause disruption from the standpoint that there will be some pricesthat primary clients are going to have difficulty paying becausethey havent raised primary rates enough.”

James Vickers, managing director-reinsurance for Willis Ltd. inLondon, does not believe the industry faces a major marketdislocation. “I think that the capital supply is still there,” hesaid. “Its just that the people who actually own the capital arenow much more cautious about using it.”

Dislocation was a big factor of the 1992-1993 period, when “youjust could not get things done,” he said. “It really didnt matterhow much money you were prepared to pay, [business] just could notbe placed. The market is nowhere near that situation.”

He thinks that reinsurers that do have sufficient capital arenot looking to gouge the market in the way “that perhaps took placein the early to middle 1990s.”

“A number of people are saying, If the price reaches the levelthat we require to make the necessary return, well write it,” Mr.Vickers continued.

The problems occur because reinsurers reduced their ratesenormously and now theyre moving up again more quickly than theprimary markets, “so [primary companies] are being squeezed betweenthe two,” he said.

If a primary company starts to increase their rates on theiroriginal portfolio, it may take 18 months for that to appear on thebottom line, but in the meantime, the reinsurers have asked forimmediate price increases, “so theyve got a bit of a cash-flowcrunch on their hands,” he said.

“At the end of the day, the industry still has capital and infact it still has too much capital,” Mr. Vickers said. “So, whilesome people may pull out of lines of business, there will be otherswho will be tempted into it, admittedly at probably higher pricesand at tighter terms and conditions than the othersbut they willstill be tempted in.”

Mr. Mahoney thinks the market is shrinking, but voluntarily thistime around. “Companies that are solvent and that are decent areactually withholding capacity,” he added. “In the past, when themarket started to get harder and rates started to go up, companieswould say, 'Okay, Ill commit more capital and write more businessright now.'”

Currently, however, many reinsurance company managers aresaying, “Lets wait a bit longer before we jump in here again,”according to Mr. Mahoney.

Part of the current market contraction is happening at Lloyds,he said. “Theyre going through a massive re-thinking of how theyshould be approaching the world,” Mr. Mahoney said.

A lot of the capital at Lloyds is provided by corporate members,and since that capital is backed by insurance and reinsurancecompanies, “theyre going to react in the same way that we react onthe insurance and reinsurance side–like a company,” he said. As aresult, the reaction will be faster than it has been historicallyat Lloyds, he predicted.

The current rate strengthening is significant and time will tellwhether its enough, according to Don Watson, director of Standard& Poors Insurance Ratings in New York. “But you will not havethe rate hardening that we saw post-1986 in the liability side andwe will not see the rate hardening that we saw post-1992 in theproperty market,” he affirmed.

He doesnt expect the same level of increases as occurred in the1980s and early 1990s because capacity hasnt withdrawn. “There isfar more disciplined underwriting than has existed in a long time,”he said.

Reinsurers are coming off programs and that is causing awithdrawal of capacity, but the capital is still there, and asrates rise, more capacity will become available, Mr. Watsonpredicted.

However, Mr. Mahoney does not think that the current ratehardening will bring in a spate of new players, akin to whathappened after Hurricane Andrew in 1992.

If that does happen, it wont be soon, he said. “I dont think thereturns are very attractive right now for new capital to come intothis business,” he added. “Maybe if they see a year or two withoutcats and nice hard rates, then youll see lots of capital comingin.”

Mr. Watson thinks that the fun is coming back to reinsurance. “Ithink that the underwriting discipline that is appearing in themarketplaceis allowing companies to differentiate themselves on thebasis of selection of risk,” Mr. Watson continued.

“You havent had that opportunity in over a decade,” he said.“With the exception of Australia, if you wrote property reinsurancepost-1994, you couldnt help but make money.”

Companies with well-developed underwriting expertise will now beable to significantly improve their results, so its going to be alot more fun, Mr. Watson said. “It doesnt mean that theyre going tobe hugely profitable, but its going to be more interesting than thelast five years where its just been a steady downward trend,” headded.

Reproduced from National Underwriter Property &Casualty/Risk & Benefits Management Edition, September 10,2001. Copyright 2001 by The National Underwriter Company in theserial publication. All rights reserved.Copyright in this articleas an independent work may be held by the author.

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