As a result of the ongoing soft market, a “whoblinks first” environment pervaded Jan. 1, 2011 reinsurancerenewals, with buyers holding out for the best terms andreinsurance underwriters standing firm or pushing back, accordingto market participants.

During a late-December 2010 NUinterview, Robert Childs, chief underwriting officer at Hiscox,which writes both insurance and reinsurance, said primary insurerswere starting to move to end the stalemate, providing his ownanswer to what he said was the key question of the Jan. 1 renewalseason—“Who blinked first?”

While renewals for the internationalmarket went through “much as expected,” American business with U.S.exposures took longer, he said, speaking from the perspective of areinsurer.

Mr. Childs, who is also chairman of U.S.specialty insurer Hiscox USA, reported that movements on thereinsurance negotiations during the last two weeks of December madeit “a late renewal season.”

“I think the [primary insurance company]clients are pushing very hard, looking for reductions,” he said.The process took longer than expected, because while quotes wentout, people were not getting early orders on the quotes, he said.Buyers were “constantly trying to adjust them, [asking,] 'Can we doslightly better?' he said.

On the whole, he said, the reinsuranceunderwriting market appears to be very disciplined.

While it is Mr. Childs' contention that primaryinsurers blinked when they grudgingly signed deals that weren'tquite as attractive as they had hoped for, two reinsurance brokersrecently reported that buyers saw better prices for 2011 than theydid for Jan. 1, 2010 renewals.

“Overcapitalization in the reinsurance marketcontinues to gradually push rates downward with price reductions atthe Jan. 1, 2011 reinsurance renewals averaging between 5 percentand 10 percent,” London-based Willis Re said in a statement.

“Reinsurers are now lowering rates at the same,or faster, pace than insurers are lowering rates,” saidChicago-based Aon Benfield in a separate report.

In yet another report from a reinsurancebroker, New York-based Holborn noted discipline on both sides.

“Reinsurers believe that some ceding companiesare 'doing the right thing,' resulting in improved contractbalances and lower exposures to reinsurers,” the Holborn reportnoted. The lower exposures, however, also translate into lowersubject premium income (SPI), the report said, referring to theceding company's premiums to which the reinsurance premium rate isapplied to produce the reinsurance premium.

“Reinsurers, like primary companies, arestruggling to keep their good accounts and maintain their volume,and thus have to reward good experience. But they also seek topreserve some balance between the premiums they accept and thelimits they provide,” the report said.

“For accounts with lower SPI bases, thistranslates into a desire for [reinsurance] rate increases, even forpreferred clients,” Holborn said, noting that the most commonrenewal situation in the market this year is flat to moderatelylower rates-on-line (ratios of reinsurance premium to reinsurancelimits), in tandem with moderately higher rates.

SUPPLY/ DEMAND DYNAMICS

Commenting on the demand for reinsurance, Mr.Childs said that over the last year and a half, primary insurershave looked to retain more risk, but that the situation couldchange in 2011 with a new model by Newark, Calif.-based RiskManagement Solutions.

The new RMS model, which hesaid will “raise the bar,” is indicating that loss sizes aregreater than anticipated. “It will mean that people will be lookingto buy more cover because loss sizes will go up in the UnitedStates,” he said.

During Standard & Poor's Insurance HotTopics Conference in late December, Taoufik Gharib, director andreinsurance specialist for S&P's Rating Services in New York,said “it remains too early to tell” what the actual impact of amodel change in the works at RMS will be. He suggested,however, that higher property insurance prices for U.S. inlandareas are possible, as well as lower prices along the Atlanticcoast (See NU, Jan. 3, 2011, page 7).

In his assessment of the current market, KeyColeman, managing director for financial services consulting firmLECG in Chicago, joked: “The good news is that rates are definitelygoing to go up in reinsurance. The bad news is that it's not goingto be this year—and worse, it may not be 2012, either.”

Mr. Coleman focused on reinsurance supply tosupport his view.

“What's impacting this is capacity,” he said.“Essentially, a lot of people will measure how much you can writebased on what you have in the bank. To the extent that catastrophesdon't eat into policyholders' surplus,” reinsurers have biggerbanks, he suggested.

Insurers and reinsurers are expectingunderwriters “to go out there and use the capacity and make a goodreturn on it.”

“There's too much supply and not enough demand.That's what we're seeing again,” Mr. Coleman said.

Is it a buyers' market?

Rates in some areas have gone down a little,while others are stable, “but nevertheless, it is a soft market,”he said.

Although demand is not up this year, at somepoint Mr. Coleman said he expects that to turn around for reasonsbeyond the catastrophe model changes.

“If rates continue to go down, there will besome very astute buyers who will realize they are buying belowcost,” he said. “When they determine that it is more advantageousto buy reinsurance than to hold [risk] net for their own account,that's usually a good signal you've hit the bottom and maybe thingswill change.”

Looking back at last year, he noted some majorcatastrophes, but even the Chilean earthquake, U.S. floods andother disasters weren't enough to change either the direct marketor the reinsurance market, he said.

If something does happen to impact the marketat the end of this year or next year, “potentially, reinsurancerates would go up and direct rates would follow. Then you wouldpossibly see a spiral upward,” Mr. Coleman said.

At reinsurance broker Guy Carpenter, DavidFlandro, head of business intelligence in the London office,suggested that even a $50 billion hurricane event might not be bigenough to fuel an upward spike. (See related article, page 14.)

In the liability lines, Mr. Coleman discussedthe potential impact of loss reserve increases on reinsurancepricing going forward. “If we start to see some reserve increasesfor the 2008 and 2009 accident years, those could also impact boththe direct and reinsurance markets,” he suggested.

To the extent that some insurers and reinsurers“start to true up” reserves for prior accident years, “that couldalso suck up capacity and could have the same effect as acatastrophe on the market, causing some hardening eventually,” hesaid. “But it's going to have to suck up capacity significantlyjust to have any rate changes by 2012,” he predicted.

Peter Hearn, chief executiveofficer of Willis Re, noted dual potential stresses of loss reservechanges and lower investment earnings on reinsurer profit margins.“Thin investment returns and declining back-year releases providelittle cover for declining underwriting returns,” Mr. Hearn said.“In such an environment, any shock to reinsurers' capital base,either through underwriting losses or other capital events, islikely to result in a sharper reaction from reinsurers than primarycompanies will find easy to bear,” he said.

Mr. Coleman said another thing to watch is themunicipal market, which he said is “touched in about 10 differentways by insurers.” For example, if the “city of Harrisburg, Pa., isconsidering bankruptcy, that rocks the bond market. It makesmunicipal bonds go down and insurers hold a lot of municipal bonds,which can impact their surplus and thereby capacity.”

The other side is that “they also insurethem….So it touches a lot of nerves for insurers when themunicipalities are having problems,” Mr. Coleman said.

(Separately, in November, analysts at Moody's Investor's Service said muni-bond exposure was not a bigconcern for property and casualty insurers, with Moody'sanalysts evaluating default risk and investment income impacts. Seearticle titled “No Big P&C Problems Despite High Muni-BondLevels: Moody's,” available on NU's website www.PropertyCasualty360.com.)

Providing another summary of the underlyingdrivers and trends impacting the reinsurance market in 2011, BrianBoornazian, chief executive officer of Aspen Re, focused on sagginginvestment returns overall as a factor that should eventually driveupward reinsurance price corrections.

Speaking on a conference call hosted by CreditSuisse early this month, Mr. Boornazian observed that ahistorically low interest rate environment continues, whileunderwriting rates are static—not moving upward to adjust for poorinvestment returns.

As a result, he said that although mostcarriers will show 2010 profits, “2010 will produce industryresults that are weaker than 2009.”

Continuing his assessment, he added that “rateinadequacy in long-tail lines isn't yet being fully manifested oncompany balance sheets” and that property losses, while active,remained manageable.

So rates have only responded in specific areasthat were impacted by large losses, Mr. Boornaziansaid. 

All this leaves reinsurers at Jan. 1, withrates that, in general, are inadequate for exposures. “We aregenerally seeing most reinsurers trying to react to this situationby looking for more adequate rate,” he said.

Overall, Mr. Boornazian said that thereinsurance market remains soft, but without dramatic reductions inmost lines. “If I were to describe the market in general it wouldbe one that is bumping along on the bottom—not where it needs tobe, but not getting much worse,” he said.

“It appears that barring any significant eventthese conditions will remain the same for the balance of 2011,” heobserved. “However, the factors contributing to rate inadequacy andthe subsequent underwriting results will eventually bleed throughcompany balance sheets.”

In the end, he said, rate needs to be “adequatefor exposure, and it currently isn't. In some cases, insurancecompanies are retaining more of their business net, which willcontribute to the recognition of the need for primary rateimprovement.

“This will be compounded by the interest rateenvironment and potential drying up of prior-year reservereleases,” he concluded.

Paul Kneuer, Holborn's chief strategist, alsosuggested that current reinsurance market conditions areunsustainable. “The trends of falling prices and increasing capitalcan't both continue indefinitely,” he said. In addition, we see anumber of forces that may accelerate a market correction, includinginflation, weaker insurance-to-value, continuing active catastropheseasons, Solvency II for non-U.S. reinsurers, and mostparticularly, underreserving.”

“Barring an extreme event, these items will notinfluence conditions in 2011 and likely not in early 2012. But atsome point, financial constraints will start to influencereinsurance terms,” Mr. Kneuer said.

(Additional reporting by Mark Ruquet andSusanne Sclafane)