Cat Re 2002: A Different Hard Market?
One of the few statements that can be made with certainty about the world catastrophe reinsurance market is that it is a hard marketdefinitively so. The firming of 2001, which was driven largely by industry concerns over profitability levels and shareholder perceptions, has been replaced by a severely hardened market, fueled by dire balance sheet worries.
The effects of the Sept. 11, 2001, terrorism losses, coupled with the reemergence of asbestos, corporate scandals in the United States, and ailing global equities markets, have left reinsurers wringing their hands over capital adequacy, policyholder surplus, and rating agency assessments. A continuing lack of retrocessional capacity has compounded these concerns.
In 2002, rates for catastrophe property reinsurance cover increased in all regions of the world, and for practically all cedents. This is the third consecutive year of rising rates, after six years of soft pricing.
The current world rate on line, however, remains far below the levels of 1993 and 1994. This reflects a number of factors, including:
In 1993 and 1994, the catastrophe market was in a panic mode, following Hurricane Andrew in August 1992, which was compounded by the Northridge earthquake in January 1994. Both events caused unprecedented losses, leading to substantial increases in projections of the insured losses from mega-catastrophes.
At the same time, modeling of catastrophes was in its infancy. This meant that there were few absolute benchmarks on the pricing of catastrophe risk, and the basic tendency was to charge what the market would bear. By contrast, in 2002, expected losses from natural perils are model-based and fairly stable from year to year.
The perils causing the hard property market in the early 1990s were perils that continued to be reinsured. For example, after Hurricane Andrew, rates were increased for insurers exposed to hurricane risk. By contrast, after the events of 9/11, there has been only limited provision of terror insurance. Hence, reinsurers cannot argue that they are charging higher rates for a risk where they had a large loss and are continuing to provide cover.
The current hard market is also different from the 1993/1994 market in that reinsurers in 2002 have continued to differentiate based on clients. Cedents with relatively low losses and solid data on exposures have consistently faired best in terms of reinsurance price and availability.
The reinsurance catastrophe market for terrorism essentially evaporated immediately after Sept. 11, 2001, after having given the cover away essentially free of charge in prior years. Reinsurers have since modified their positions, but coverage is still being provided only on a very selective basis, and availability varies widely by country and line exposure. A number of countries are considering establishing a special pool mechanism to handle the exposure. New pools have already been instituted in France and Germany. A similar system is being considered for the United States.
The new capital that entered the market post-Sept. 11, 2001, is another factor that is both significant and different in 2002. This capacity has entered the market at a much faster pace than in 1993/1994. Overall, this capacity has been applied conservatively, helping to keep the market turn somewhat in check. This inflow of capacity has also helped to stem the flight many expected to alternative risk transfer programs, including catastrophe bonds. While the level of catastrophe bond transactions in 2002 is likely to surpass that of 2001, these transactions are still only a small part of the overall catastrophe risk transfer market.
Examination of the worlds two largest catastrophe reinsurance markets, the United States and Japan, further highlights the unpredictable nature of the current market:
In the United States, where insurers are concerned primarily about exposure to the natural perils of earthquakes, windstorms, hurricanes, tornadoes, wildfires, hail and floods, catastrophe reinsurance rates rose in almost all sectors at 2001 year-end renewals, yet companies generally had little problem securing capacity. At Jan. 1, 2002, renewals, significant price increases were again the norm, but now paired with tightened terms and conditions. The average rate on line in 2002, as measured by Guy Carpenters index based on major programs, increased for the third year in a row, as shown in the accompanying bar graph.
Exclusions for terrorism, toxic mold and cyber risk were selectively imposed. Many additional coverages that had been readily tossed in through the soft cycle were eliminated.
The average limit increased, reflecting insurers concern about exposure to mega-catastrophes following Sept. 11. Cedents also retained more risk at various layers, probably in an effort to control reinsurance costs and retain more net profitable business in a hard primary market.
In Japan, where earthquake is of paramount concern, fears that Japanese earthquake capacity would be reduced after Sept. 11, 2001, proved unfounded. Rather, reinsurers were eager to take advantage of the hardening market for excess-of-loss business, and offered proportional earthquake capacity on an accommodation basis. Several Japanese insurers purchased increased excess-of-loss limits on their net retentions.
New Bermudian capacity that entered the market after Sept. 11 offset to some degree losses of capacity that did occur due to the withdrawal of some global reinsurers and the reduction in pro rata earthquake capacity available from others.
Unlike in the United States and other markets where external factors only exacerbated current conditions, in Japan, some external factors, such as the weakening yen against major currencies and the new infusion of capacity, actually worked in insurers favor, making the Japanese market "less hard" then it might have been without the impact of Sept. 11.
Generally, on a like-for-like basis, it seems that a number of Japanese programs, practically all of which start April 1, renewed at a price similar to that of last year, if the program was deemed by reinsurers to be technically rated. Prices increased when more capacity was purchased.
In the case of windstorm, another major exposure for Japanese insurers, most of the larger companies renewed programs similar to those expiring. Several elected to purchase increased limits at the higher end of the program. Without exception, pricing for windstorm business rose at 2002 renewals, from 15 percent to 60 percent, depending on the perceived level of 2001 pricing compared to the correct technical pricing and on past loss experience.
How long will this hard market last? Predictions are difficult, if not impossible, at this juncture. This hard market seems to be breaking the rules and will likely continue to buck historic norms. With a continued weak global economy hurting investment income and significant losses from lines other than property, such as directors and officers liability, the reinsurance catastrophe market will remain under pressure. Any major loss activity will, of course, increase that pressure, perhaps dramatically.
For the coming year, at least, insurers should plan for more of the same: a hard market for catastrophe reinsurance worldwide. However, there is hope that the increased capacity in the marketplace and improved industry returns may mean that the worst is over.
Sean F. Mooney is senior vice president, research director, and economist at Guy Carpenter & Company in New York. This article is based on "The World Catastrophe Reinsurance Market: 2002," published by Guy Carpenter this month.
Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, September 2, 2002. Copyright 2002 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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