Red ink spilled over the bottom lines of midyear Bermuda-market financial reports, but executives are signaling a top-line upside from catastrophe losses that they see altering the mindsets of some key customers—namely, cat-reinsurance buyers.
In addition, despite the fact that only two of the 10 publicly traded Bermuda insurers and reinsurers that released earnings by the end of July reported positive numbers on their net-income lines, the capital levels of the cat-protection sellers remain strong, market participants and analysts say—highlighting the market’s ability to take it on the chin (see charts).
“When you look at the extraordinary size of catastrophes in the world over the past 15 or 18 months, what is amazing is the Bermuda market—the center of global cat reinsurance—is absolutely intact,” says Ed Noonan, chair and CEO of Validus Holdings.
“You don’t see companies having to leave the market. Capital has not been impaired,” he tells NU.
In fact, based on a compilation of 2Q earnings reports from 10 Bermuda players, there has only been a 3 percent hit to capital since Dec. 31, 2010—even as first-half cat losses blew up combined ratios for the group by nearly 30 points.
And some of the capital drop has been intentional, as market players bought back shares, taking advantage of low-market valuations to enhance returns-on-equity.
MARKET-TURN CRITERIA: MET; FULL RMS IMPACT: NOT YET FELT
Chris O’Kane, CEO of Aspen Insurance Holdings, puts the worldwide insured-loss total through the first six months of 2011 at $66 billion, including $18 billion attributable to second-quarter U.S. cat events.
O’Kane notes that the first-half figure eclipses the $40 billion full-year total for 2010. As a result, “a discernable change in the industry mindset is now taking place,” Kane says. “The pre-conditions in support of market turn have now been met.”
In addition to the high and costly incidence of natural disasters, O’Kane points to another key factor influencing a market shift: the exposure changes being revealed to users of the new Version 11.0 U.S. wind-cat model released by Risk Management Solutions in March.
While the model changes have begun to have an impact, O’Kane adds that the full boost of the RMS revisions on reinsurance demand is a long way from being realized.
About 80 percent of U.S. primary insurers use RMS as at least one of their models, but “currently, it appears to us that less than a quarter of these companies have reflected [the model changes] in the way they have calculated PMLs [probable maximum losses], their reinsurance purchasing needs and prices,” O’Kane says.
Offering some enormous numbers to illustrate the potential demand upside of increased model usage, O’Kane says that a 1-in-100-year market loss for U.S. wind came in at $120 billion under the prior version of the RMS model, but that the new version vaults this up to $180 billion.
$20-60 BILLION DEMAND SWING; CAP MARKETS TO GET DRAWN IN
Against that $60 billion swing, Aspen has only identified $2.5 billion of additional U.S.-catastrophe limit that was purchased across the reinsurance market at midyear, O’Kane says, adding that he is aware that many primary insurers have delayed decisions about how to respond to model changes until the fourth quarter.
Robert DeRose, a rating analyst and vice president for Oldwick, N.J.-based A.M. Best, would not venture to assess the accuracy of those figures for NU. “But in theory, we would agree with the sentiment of the statement,” DeRose says.
“While July is a significant renewal period, January is much larger—and primaries are just starting to come to grips with the model changes,” he says. “It’s safe to say more reinsurance will be bought, but we can’t say exactly how much.”
O’Kane concedes that the $60 billion figure is valid only if every model user fully buys into the changes RMS has introduced. While that may not be realistic, “there is still probably $20 billion of additional demand,” he says, adding that “the reinsurance market is not capable of supplying that amount of demand. The capital markets are going to get drawn in.”
Noonan agrees. “You end up with significantly more demand for reinsurance. It may not be $60 billion, but it will be pretty material,” he says, adding that Validus is already involved in a capital-markets venture, having launched a sidecar reinsurer, AlphaCat Re 2011 Ltd., in early June.
(Essentially the vehicle, which is focused on retrocessional cover, manages capital for third-party investors—allowing them to enter the cat-reinsurance arena without having to staff up a company or develop an exit strategy at a future time when the hard-market opportunity fades.)
Bermuda executives and analysts note that while primary insurers have moved more slowly to vet revised model assumptions, the science behind the changes is not new to many Bermuda reinsurers that have been using higher-loss assumptions than RMS in their proprietary models for some time.
“So, directionally, we absolutely agree” with the revisions, Noonan says.
“One big change in the model that nobody talks about is a higher frequency rate,” reflecting a period of heightened storm activity, says Noonan. “We and other companies have been pricing in that view for the last five years.”
Noonan also believes the changes in model assumptions about how quickly wind dissipates after it crosses the shoreline make it more accurate, but says Validus is still working on understanding why RMS has incorporated a Danish storm-surge model that differs from a FEMA model more widely accepted by Bermuda reinsurers.
On the wind assumption, he says, “Historically, the AIR model had a much bigger wind field,” referring to Boston-based modeler AIR Worldwide. “We always had the view [that] RMS didn’t actually have it right.”
Noonan also notes that RMS’s data for actual past-loss events “is not perfect,” adding that Validus is working with Florida insurers to validate their experience against what RMS is coming up with. “There are meaningful differences,” he reports.
While model validation will take time, causing insurers and reinsurers alike to modify areas they do not agree with, reinsurance demand and pricing will still climb at Jan. 1—even if this year’s hurricane activity is average, Bermuda executives agree.
Commenting on the consequences of a no-loss or average wind season, Joseph Taranto, CEO of Everest Re, observes that even if reinsurers make money on Florida through wind season, “there’s a psychological part as well as the economic part” that factors into pricing determinations.
“How much do we rely on history which didn’t have four earthquakes happening in a year-and-a-half? How much do we rely on models that can’t contemplate everything?” Taranto asks. Reinsurance buyers realize that cover is needed for volatile losses, he concludes. And sellers are being pragmatic: “My gut instinct is I don’t care what models say. I need more rate,” he says.
RATES, NON-RENEWALS & RETROCESSIONAL COVERAGE
Even as Bermuda executives chat up the pricing upside of cat events and model changes, they also are describing moves to protect their balance sheets by purchasing more retrocessional cover. This strategy of retaining less cat business will also give them room to grow when the harder Jan. 1 opportunities surface.
Also, several reinsurers have nonrenewed chunks of business in certain geographies.
Lancashire Insurance CEO Richard Brindle, for example, says his company nonrenewed its entire book of Florida-domiciled cedents, reporting that Lancashire saw no signs of the double-digit rate increases being touted by others. “None of the submissions we were shown when properly adjusted for RMS 11 were anywhere near that. Indeed, in many cases they were substantial reductions.”
O’Kane reports achieving average rate hikes of 13 percent for the U.S. at midyear, 89 percent in Australia and 49 percent in Japan, while Michael Price, CEO of Platinum Underwriters, says there’s no clear sign of a hard market in Australia and reports that Platinum nonrenewed its entire New Zealand book.