As a robin or crocus is often regarded as a sign of spring, so is the appearance of a reinsurance broker promoting “reverse flow” business a sure indication of a wicked soft market. Actually, a more apt comparison might be to a groundhog's retreat from its shadow on Feb. 2. When reinsurance brokers talk up reverse-flow options, you can kiss good-bye any illusions you may harbor for an early end to a soft market.

Reverse-flow transactions mainly affect program business but have implications for anyone interested in the underwriting cycle. Typically, program administrators obtain their coverage from primary insurers, which then lay off part of the risk with reinsurers. But when the market is particularly soft and overcapitalized, primary carriers don't cede as much business. In response, reinsurers may try to get their share by going directly to program administrators or MGAs, urging them to consider a “structured” program, in which a “fronting” carrier issues policies for the program administrator, then cedes 100% of the premiums to a reinsurer.
Last month, at the annual convention of the Target Markets Program Administrators Association, which was held in Tempe, Ariz., I spotted a reverse–flow broker-the first one I'd seen since the 1990s, well before Target Markets was even formed–in the form of Dean Carberry, chief executive officer of Rattner Mackenzie (Bermuda) Ltd. During a break-out session he conducted, he gave his take on where the market stands today, more than three years after the last gasp of the hard market. Among its characteristics are:
–Enormous capacity: The last soft market came to a screeching halt in 2001, Carberry said, when poor underwriting results and the shock of 9/11 produced an industrywide combined ratio of nearly 116. Then, as a market correction set in and rates for many risks skyrocketed, capacity flooded the market–and then kept coming despite the hurricane-related losses of 2004 and 2005 (which, of course, produced corrections of their own). All that capacity has increased industry surplus, the capital that supports underwriting. Surplus “is at an all-time high of $512 billion,” Carberry said. “That's just incredible.” As Bermuda markets and other players increase their presence in the U.S. market, Carberry said surplus could top $600 billion by year end.
–Record profitability: The insurance industry's combined ratio plunged to 92.5 in 2006–meaning it made a 7.5% profit before interest income–and 2007 is shaping up to be almost as strong. “The results that we're seeing at the moment are the best ever … for combined ratios since 1949,” Carberry said. “Not only are they the best results, but they are the longest-sustained (profitable) results.”
–Anemic growth: “The market's not getting any bigger,” Carberrry said. “In fact, it's possibly (shrinking) because of rate reductions and increases in self-insured retentions.”
Carberry said these and other factors point to a soft market that, while perhaps not as deep and long-lasting (12 years) as the last one, likely will hang on for another four to seven years. Interest rates will be one key determinant, he said. Although they've dropped recently, Carberry said he believes they are likely to rise as the government finds it has to borrow more to cover the cost of such programs as Social Security, which baby boomers will begin tapping next year. Higher rates would enable insurers to increase investment income, which would prolong the soft market, he said. In today's extremely competitive market, program administrators can find plenty of insurers interested in partnering with them, Carberry said. (Indeed, the Target Markets attendance list included several carriers who were new applicants for association membership.) Insurers are now more willing to accept smaller programs, delegate authority and make other concessions, he said.
“Finally, reinsurers are ready to take 100% quota shares,” Carberry said. “Normally reinsurers would only come into the market if the insurance carrier was taking a big retention on the risk. They're bypassing all that now, going directly to the MGA (or program administrator) and saying, 'Get me a front carrier. I'll take care of everything after that.'” Such arrangements can have advantages for program administrators, Carberry said, including a significant share in underwriting profit.
As the market continues to soften, Carberry predicted there will be considerable consolidation among carriers and program administrators. “Size counts, for sure,” he said. “The bigger your program, the most likely you are going to survive.” In coming years, he said, as profits deteriorate under relentless rate cutting, $5 million programs with 65% loss ratios will be doomed. “If you don't have a significant volume, there's no investment income,” he said. “You won't stand a chance.”
Meanwhile, the soft market won't really last forever, the way winter froze in place for Bill Murray in “Groundhog Day.” It will only seem that long.
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Earlier last month, at the annual convention of the National Association of Professional Surplus Lines Offices, which was held in New Orleans, an emotional highlight was a brief address by Louisiana Insurance Commissioner James J. Donelon, who said the city and state are back, after “a horrific time.” He said the participation of E&S carriers in the Louisiana insurance market will be vital to its recovery and offered “Three L's” as incentives: Legislative efforts (e.g., a $100 million program that provides matching funds to qualified insurers committing capacity to the state), levees ($1.5 billion in federal funds spent so far to strengthen levees, with more on the way) and litigation (or rather, the potential for less of it, thanks to the state's Napoleonic code, which Donelon said permits punitive damages only for drunk driving and child abuse). Here's hoping that insurers take the commissioner up on his invitation.

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