Despite many factors that should be contributing to a hardening market overall, competition in some coverage lines and geographic regions has heated up, while activity in many other areas remains tepid, keeping price hikes more modest than anticipated, reinsurance experts say.

Chris Klein, global head of business intelligence with Guy Carpenter in London, said in January buyers overall saw moderate increases, which he said means expectations of higher prices last fall were not met. The important theme now is that while prices at renewal were up about 15 percent on average, that amount was below the anticipated hardening of about 20 percent.

He added that April 1 renewals, significant in Asia, produced mixed signals as well, with the market generally flat.

As July 1 renewals were being closed, he reported, the market could be described as “tepid, with hot spots.” Mr. Klein explained that retrocession remains reasonably tight, but is available.

Early reports show tightness in U.S. catastrophe programs. The Northeast U.S. coast overall, he said, is “tight” and a “hot spot.” The same goes for property-catastrophe and marine and energy risks in the Gulf of Mexico. Trade credit and surety, he added, has been hit hard by the recession, particularly in Europe.

What's tepid? He noted that the general casualty market remains flat, and aviation looks “interesting,” although renewals in October will tell more. Mr. Klein added that the Air France crash off the coast of Brazil appears to be the biggest aviation loss in several years.

He also said the U.S. primary insurance market remains competitive in almost all lines and classes of business.

However, there are several factors at play, he explained, which ought to be providing an underpinning of pricing, terms and conditions, while keeping at least “a floor under the market,” if not continuing to push prices up. Among them:

o Low investment returns. With interest rates historically low and with low yields, revenue coming in from investments is much smaller than in the past. This is an issue for casualty business, Mr. Klein said, where reserves are held for long periods of time and income from those reserves is substantial.

o Reserve releases. “If you look at recent results, particularly in the first quarter, you'll see that underwriting results have been held up or boosted by reserves from prior loss releases,” he said, adding that “these can be quite substantial in some cases, and many of them are post-Sept. 11, 2001.” However, surplus reserves are a finite resource, one which may be drying up. As that happens, prices might have to go up to compensate.

o Tight capital markets. “People were affected by the financial catastrophe last year, which in turn weakens balance sheets,” noted Mr. Klein. Although many reinsurers entered 2009 with strong balance sheets, capital has been reduced, “which in theory is the supply,” he explained.

“What underpins the supply of reinsurance ought to be driving prices,” he said. “There has been uncertainty over the ability to replenish balance sheets in the event of a major cat loss.”

He said that in theory, underwriters hold back their capital because of fear there may be a big loss and they won't be able to easily raise money from external sources. “So again, that tightens the supply of capital, and you'd expect to see price pressure,” he said.

o Pressure by rating agencies, which want to see better returns, higher rates, lower volatility, “and they want to see companies stabilizing and rebuilding balance sheets,” he noted.

The paradox, he added, is that to rebuild a balance sheet, “you need to earn profits, and to get a better return you need to increase the profit against the balance sheet. But if you're having to hold a bigger balance sheet, that puts pressure on trying to get the return.”

He said that in Florida, renewals were “finely balanced,” because “most people were able to get what they wanted, [although] they had to pay some more for it.”

Evidence of that balance, he said, was the fact that the gap between the highest and the lowest quotes for reinsurers was only six percentage points, “which is a very narrow spread.” Mr. Klein said the spread generally is wider when buyers are testing the market.

The second factor was that prices, terms and conditions at which the reinsurance treaties were bound and agreed were at rates 95 percent of the average quote–a narrow spread between what was quoted and what was bound. In a softer, more competitive market, he added, that spread would be much wider.

What's bringing this about? “Volatility is reducing and confidence is coming back into the equity market,” he said. “So while you have these drivers on both sides, the fact is that the reinsurance market began last year with a lot of capital.”

Brian Boornazian, president of both Aspen Re and Aspen Re America, observed that in the property market, buyers tend to be most interested in property-catastrophe coverage this time of year, in the midst of hurricane season.

Currently, the property-cat market is “relatively orderly,” he noted. “As an industry, we've seen pricing to be up–roughly 15 percent. That's off of a higher base than previous soft markets, so I think we're in a relatively good place in the property-catastrophe market.”

The highest increases are primarily in peak-zone wind or earthquake-exposed business, he noted, with the location of the exposures determining how much of an increase will be seen. “If you're a regional carrier without peak-zone exposure, you'll probably pay single-digit rate increases,” Mr. Boornazian said.

He noted that capacity has remained relatively static for the past year or so, because of the financial crisis.

Looking forward, however, “there are signs that possibly some new capacity may enter the property-catastrophe market,” he reported. Nevertheless, while many buyers are trying to get their renewals done early, he said indications are that most peak-zone capacity so far has been met.

OTHER TRENDS

In the general property risk reinsurance market, the industry is seeing “a bit more varied result, but we are showing some signs of improvement there as well–but not to the extent we're seeing in the property cat market,” according to Mr. Boornazian.

He also observed that while the U.S. facultative market is “fairly attractive right now,” some cedents are substituting their treaties for buying facultative coverage.

“So they're exposing their treaties more to some risks that they normally would have purchased facultative to protect,” which he said gives the reinsurers more exposure to business they otherwise weren't exposed to in previous years.

Mr. Boornazian said this happens when companies feel they need more premium to fund their risk, but can't afford to pay the additional amount for facultative. “So they then go and expose their treaty to the risk instead,” he explained.

In the U.S. casualty markets, he observed, rates are improving overall, “but by that I mean the rate decreases are smaller than they had been previously–so the rate of descent is slowing, in other words.” He said the rate decreases have been gradual, “almost on a monthly basis.”

Mr. Boornazian noted that the market is lagging because of some recent entrants into the U.S. excess and surplus lines world over the past year, “as well as some of the larger companies that may have had their balance sheets affected negatively, for other reasons.” Those companies, he said, are struggling to “retain the business they once had, and I think those all contribute to rate levels not being what they need to be.”

An interesting line to look at, he said, is workers' compensation, where there is “a fair deal of uncertainty on excess workers' comp.” This is mostly due to the uncertainty of medical inflation. “If you look at the larger economic and political climate, there's a lot of prognosis for an inflationary cycle, and this is a business with a very long tail,” he noted.

In the casualty market overall, Mr. Boornazian said investment income is down because of the “macro-economic environment.” Without a “healthy stream of investment income,” he added, “rates will have to go up from current levels. Otherwise companies are not going to be able to write this business to acceptable returns.”

When will this happen? Industry watchers “think it needs to happen, starting in the second half of this year,” he said, “or you may see some reinsurers pulling back capacity, you may see pressure on acquisition costs, but something will have to happen.”

Regarding the errors and omissions and directors and officers markets, “rate improvement needs to take place here,” he said. “We don't know if we've seen all the players admitting all their losses from the credit crisis yet. Part of that is because they just don't know–it's still early.”

William Jewett, president and chief executive officer of Endurance Worldwide Reinsurance, described the recent Florida market renewals as “orderly.” For property-cat coverage at June 1 renewals, he said submissions were early, particularly compared to last year. Transactions also were closed later, making the actual timeline longer.

“Because of the complexities of the market and increased rates, companies looked at different alternatives to optimize their programs, which led to longer underwriting decisions,” he said.

Mr. Jewett said buyers facing a firming market with less capacity were creative and looking at options. As a result, he said, fewer programs were oversubscribed. In terms of actual preparation, “it was more about companies realizing that in the property-catastrophe market–specifically the wind marketplace in Florida and the Gulf–there would be some hardening.”

Because of the hardening market, he said even before the submission process began companies were considering alternatives. Those included increasing retentions for some, hiking retentions and buying more at top layers for others, and for some keeping retentions flat and buying less.

“We observed companies looking at their premium spend, considering risk characteristics, evaluating their options and making informed decisions,” he noted.

Overall, he described the reinsurance market as “responsible, unlike in prior soft markets,” observing that “in prior cycles, reinsurers led the market,” while now, “it's not reinsurers driving the insurance cycle.”

Reinsurers' prudence can be attributed to a few things, he said, including better informed management, looking back at lessons learned, capital constraints and the focus of ratings agencies on balance sheets.

Another factor, he added, is a better quality of executive management in some companies now versus prior cycles. Given the financial crisis and the fact that capital is “so dear,” he said, there is more care as to how that capital is deployed.

In general, he concluded, it's “a market in which you can make money and transact, but it's not hardening in the classic sense and it is certainly not a hard market. It's a stable market that's still very competitive, with some hardening signs.”

David Perez, president and chief underwriting officer of global casualty with Torus Insurance–which completed its first year of business on June 23–noted that in the casualty world, “we're seeing a tremendous amount of competition that still exists, especially in the lead umbrella environment and to a great extent, for large, national global accounts.”

This competition, he said, “has an effect on pricing throughout the tower, but in the excess lines of business above that, the softening has appeared to level off.”

In reinsurance, he said, capacity is available, “but has been difficult to come by. We're very fortunate that we had the ability to fill out our placements.”

He added, however, that there has been much concern about the casualty market expressed by the reinsurance community, “and really about the continuing soft market, matched with the continued adverse development of years–not only 2001 and prior, but now we're seeing 2003 and prior years facing some adverse development.”

Mr. Perez, who is based in the Bermuda office of Torus, noted that during the 2003-2006 period, “there also were a number of reserve takedowns, or redundancies considered in prior years in the U.S. property and casualty market. If these years start to trend adversely, it's going to have a significant effect in the marketplace.”

He said this “has a lot of reinsurers concerned, in terms of adding more capacity into the marketplace, or even continuing existing lines.”

“We know there are certain sectors right now that are facing significant challenges in capacity, especially in certain energy sectors,” according to Mr. Perez. “We think that's driven primarily because of some tremendous losses that sector had to absorb–not only on the casualty side but also on the property side.”

While capacity most likely won't change much globally, the appetite for risk within those gross lines will change, he said.

In addition, “we know there was a dynamic shift in purchasing in the casualty sector that took place over the past six months,” he said, noting that risk managers and buyers were being questioned internally as to why a company would be “so leveraged into a few select markets, and what is the criteria for that.”

Even more important, he added, buyers are wondering when a certain amount of cover is “too much leverage into a carrier, and there's really no response to that.”

Because some carriers have had significant challenges over the last few months, he said buyers are thinking differently. Carriers that generally had significant amounts of capacity have adopted a more de-leveraged approach, “in terms of scaling back large limits with certain carriers, or a syndicated approach where capacity is shared by more carriers–that's a significant shift in how capacity is bought in certain venues.”

He said there also is more involvement on the part of the insureds, which “isn't necessarily a bad thing.”

On the direct side, according to Mr. Perez, while competition is part of the process, “we need to make sure the pricing is adequate for the exposure we'll have, and that we're communicating the reasons why there may be a need for a price change or coverage change. Communication is key.”

He also observed a “wonderful renaissance over the past few quarters” in Bermuda, “where a tremendous amount of new capacity has come into the marketplace.”

More so now than ever, he said, insureds coming to Bermuda have more options, in terms of capacity. “It's a very exciting time and something that cannot be promoted enough in the U.S. marketplace, in terms of what the Bermuda markets can do for large buyers of capacity,” Mr. Perez said.

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