Some Dislocation ExpectedAs Reinsurers Rewrite Books

London Editor

Will the current market hardening lead to a major dislocation and withdrawal of reinsurance capacity? Will there be a return to the hard market of the 1980s, when coverage in some lines was next to 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 soft market, then theyve got some surprises in the form of prior-year loss development that wasnt really anticipated,” Mr. Mahoney told National Underwriter. “Theyve been eating into their reserves over a long period of time and writing under-priced business.”

He noted that many companies have bought various types of finite coverages or funded spread-loss programs, which make the results look better than they actually are. (He said that St. Paul also uses 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 negative factors by “getting the prices up and tightening up on the underwriting terms and conditions,” he said. “The strong companies are not going to go bust, but they know that theyve dug some huge holes, and if youre a strong company and you want to stay a strong company, you have to quickly put your balance sheet back in a very healthy state.”

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

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

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

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

James Vickers, managing director-reinsurance for Willis Ltd. in London, does not believe the industry faces a major market dislocation. “I think that the capital supply is still there,” he said. “Its just that the people who actually own the capital are now much more cautious about using it.”

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

He thinks that reinsurers that do have sufficient capital are not looking to gouge the market in the way “that perhaps took place in the early to middle 1990s.”

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

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

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

“At the end of the day, the industry still has capital and in fact it still has too much capital,” Mr. Vickers said. “So, while some people may pull out of lines of business, there will be others who will be tempted into it, admittedly at probably higher prices and at tighter terms and conditions than the othersbut they will still be tempted in.”

Mr. Mahoney thinks the market is shrinking, but voluntarily this time around. “Companies that are solvent and that are decent are actually withholding capacity,” he added. “In the past, when the market started to get harder and rates started to go up, companies would say, 'Okay, Ill commit more capital and write more business right now.'”

Currently, however, many reinsurance company managers are saying, “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 they should 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 reinsurance companies, “theyre going to react in the same way that we react on the insurance and reinsurance side–like a company,” he said. As a result, the reaction will be faster than it has been historically at Lloyds, he predicted.

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

He doesnt expect the same level of increases as occurred in the 1980s and early 1990s because capacity hasnt withdrawn. “There is far more disciplined underwriting than has existed in a long time,” he said.

Reinsurers are coming off programs and that is causing a withdrawal of capacity, but the capital is still there, and as rates rise, more capacity will become available, Mr. Watson predicted.

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

If that does happen, it wont be soon, he said. “I dont think the returns are very attractive right now for new capital to come into this business,” he added. “Maybe if they see a year or two without cats and nice hard rates, then youll see lots of capital coming in.”

Mr. Watson thinks that the fun is coming back to reinsurance. “I think that the underwriting discipline that is appearing in the marketplaceis allowing companies to differentiate themselves on the basis 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 reinsurance post-1994, you couldnt help but make money.”

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

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

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Some Dislocation Expected As Reinsurers Rewrite Books

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