In a development that is eliciting some mixed feelings, some $35billion in capital has recently entered the reinsurance market fromhedge funds and pension funds, both nontraditional sources. Andwhile Aon Benfield sees this surplus of capital as a boon forreinsurance clients, Willis Re has been decidedly cautious. Bothreinsurers issued market outlook reports to coincide with April 1renewals.

Aon Benfield's Reinsurance Market Outlook notes this new capitalcoming into the insurance-linked securities (ILS) andcollateralized reinsurance market gave some of its clientsrisk-adjusted pricing decreases of 25 percent to 70 percent in U.S.hurricane and earthquake exposed areas—the lowest ILS costs ofreinsurance for peak perils since 1992's Hurricane Andrew. Thecompany says it expects to see “continuing material benefit forclients” as it looks forward to June and July renewals.

Aon Benfield's clients stand to benefit from this supply anddemand dynamic, as it gives the company an opportunity to offerbetter terms to its buyers, says Greg Heerde, head of Americas forAon Benfield Analytics.

“We've seen capital rise from $455 billion in 2011 to $505billion, at the end of 2012, an 11 percent increase and a recordamount for the reinsurance industry,” Heerde says. “Using reinsurercapital as a proxy, supply is up while demand is relativelyflat.”

Wills Re's First View notes that property/catastrophereinsurance capacity is a threat to portfolios: a surplus withoutmuch demand that is only creating stagnant sales and pricecompetition. James Kent, President, Willis Re North America, saysone problem is that reinsurance buyers in general are notincreasing the reinsurance purchase limits that they buy.

Yet supply is up because the reinsurance industry has continuedto provide strong return on equity (ROEs) over recent years,resulting in increased capitalization from retained earnings.Moreover, despite substantial cat losses in the U.S. and globallyin 2010 and 2011, the last five years has been a relatively benignperiod for catastrophic events for the overall reinsurance market,Kent says. “Long-tail business has not produced the severity andfrequency of losses that many were forecasting with reservereleases, adding to reinsurers' returns.”

The peak in supply is creating price competition because some ofthis overflow is making its way to the traditional market players:a trend that's likely to increase in the months ahead, asreinsurers look to extend their offerings to clients that areseeking alternative forms of property catastrophe cover, Kentsays.

CAT RISKS

Companies are “challenged” to write business where the cost oftransferring or bearing catastrophe risk is high, Heerde says.

Normally, when markets like Insurance Linked Securities andCollateralized Markets increase their appetites, the pricing ofrenewals on existing ILS and Collateralized Markets dropssubstantially.

“So if you have decreased cost with catexposure, the underlying carriers can reflect that decreased costin their risk appetite,” Heerde says. Basically, insurancecompanies can grow into a higher-risk catastrophe zone than theycould before, giving them the option to evaluate underwriting inpast exposed areas; that is likely to continue to happen, hesays.

“We're encouraged by the impact for our clients, as weindicated, if the price points seem persistent (for the collateralmarkets). That is a big question,” Heerde says. “That could openthe door for our clients to enhance their strategic initiatives andpotentially grow in areas where they have actively avoided or triedto reduce exposure in before. That could be quite helpful forthem.”

Willis Re is hopeful that if North American property cat pricingcontinues to fall, “We may see buyers utilizing savings to purchaseadditional protection,” Kent says.

Kent says most reinsurers did well in 2012, asa substantial portion of the losses incurred by Sandy were retainedby the insurance market, not the reinsurance market. “It was a verymanageable loss for insurers. Despite those challenges, reinsurersstill produced good ROEs between 8 percent and 15 percent,” Kentsays.

Another factor in less-than-anticipated reinsurance appetites isongoing changes in primary market distribution models across allsegments, which continue to concentrate premium dollars into asmaller set of reinsurance players.

As primary insurers become more sophisticated in pricing andselecting risks, they're also becoming more confident in retaininga larger portion of their business and foregoing reinsurance, saysTom McIntyre, a principal in KMPG's P&C actuarial practice,based in Hartford, Conn. He specializes in risk and capitalmanagement for insurers and reinsurers.

PREDICTIVE ANALYTICS

Increasingly sophisticated pricing analytics have combined overthe last few years with slow growth during the recession, as wellas catastrophe exposure changes from RMSv11, adding up to anappetite for reinsurance that is less than what it might have been,McIntyre says.

Some insurers are looking to streamline their reinsurer panelsand place their reinsurance programs with fewer, larger reinsurancecarriers, Kent says. A broad buyer of reinsurance may go with alarger, diversified reinsurer over a specialist because the largerfirm can take a broader, overall corporate view on pricing andcapacity, rather than viewing each placement on its own.

High-tech pricing models are also putting pressure on the smallcompanies that might be the buyers of reinsurance, further thinningthe herd.

“A chief actuary from a small company told me they don't havethe size and scale to do predictive modeling,” McIntyre says. Thecompany's growth in its private passenger auto business show thatone-third of all new business in a recent period came from driversaged 65 and older. “This was not something they were trying to do;they were being selected against.”