Benfield: Reinsurers Undercutting Prices

"And though an increased use of modeling and a sharper focus on return on equity continued to exert some discipline, more and more reinsurance underwriters were willing to undercut pricing to secure attractive business."

The report noted there was ample capacity in most classes. Strong earnings and fewer reserve shortfalls eased pressure on the balance sheets, and hedge funds also brought additional capital to an already oversupplied market.

Countering the trend for relaxed pricing was the continued pressure from rating agencies, regulators and investors demanding consistent returns and capital adequacy.

Reinsurers will also have to face softening prices without the cushion of rising equity markets, Benfield said. "An essential difference between this point of the cycle and the previous cyclical downturn is that investment returns are insufficient to subsidize unprofitable underwriting," the report states.

It advised that "Capital gains, for several years the panacea for under-pricing in the late 1990s are long gone. Should optimism on pricing proved misplaced, financial distress will be felt more quickly and more acutely."

The report also tied the downgrading of reinsurers over the past three years to dislocation of the equity and global equity markets in 2002 and the early part of 2003. "The declines in the stock markets had a particularly severe effect on the balance sheets of the established European reinsurers, which historically have had heavier equity ratings in their investment portfolios," the report said.

For their part, cedants remained highly sensitive to reinsurer credit quality, particularly for casualty lines, according to Benfield. "The growing popularity of collateralization or cancellation clauses triggered by ratings downgrades is in part, a symptom of the fear of unexpected ratings downgrades," the report said.

It also noted that, "While cedants are generally content to use ratings as a criterion for selecting reinsurance counterparties, they also often seek a hedge against unpleasant surprises."

According to the report, overall property rates softened further in most areas, except for those affected by hurricane losses. Casualty rates remained stable with some exceptions, most notably directors and officers liability. While pricing softened in many lines, terms and conditions showed little or no change.

Loss-free U.S. cedants saw property-catastrophe prices drop by as much as 10 percent. However, firms with catastrophe losses saw prices rise by up to 20 percent.

A survey of Benfield brokers also found that cost was the primary concern for 32 percent of reinsurance customers, followed closely by 29 percent who were most concerned with terms and conditions.

Updated 4:20 p.m. EST