How Far Is Up For Reinsurer Renewals?

Let's start with new capital.

Late last month, former ACE Ltd. and Chubb executive Donald Kramer detailed plans to form a new Bermuda reinsurer with about $750 million in capital. In that respect, Mr. Kramer is following the playbook of other opportunity seekers who set up similar ventures in the aftermath of 1992′s Hurricane Andrew and the Sept. 11, 2001 terrorist attacks.

In addition, Warren, N.J.-based Chubb announced late last month it had entered into a strategic agreement with a private equity research firm to launch a Bermuda-based reinsurer with $1.5 billion of initial capital.

With insured losses estimated at $34.4 billion, Hurricane Katrina by far ranks number one as the worst U.S. disaster. However, the estimated $7.5 billion in new capital expected to flow into the market represents only about half, at best, of what materialized in the wake of Sept. 11–which resulted in some of the sharpest spikes in commercial lines in recent times.

Much of the new funding has come in the form of equity offerings by players such as Axis Capital, which was formed after Sept. 11 and is now in the process of raising nearly $1.75 billion.

Bear Stearns analyst David Small said "new capital may prevent tightening of underwriting standards that some reinsurance and insurance company managements have been anticipating."

"Catastrophes are integral to the insurance business and often self-correcting," added a Moody's credit analyst, Bruce Ballentine. "In the aftermath of Hurricane Katrina, we believe a well-positioned insurer should be able to raise capital, if necessary, to shore up its balance sheet and fund new business."

In its "Katrina: Post Monte Carlo Market Review," the London-based Benfield Group of reinsurance intermediaries noted that sharp post-event hikes in pricing are usual after an event of this magnitude, "but the amount and duration of the rate increases directly reflect the degree to which capital is impaired."

Then again, as Benfield Executive Vice President Charles Hewitt noted, no event in recent history can compare to the "breakout" status of the Katrina-Rita-Wilma one-two-three punch. (Hurricane Wilma caused between $6 billion and $10 billion in insured losses, while Hurricane Rita, sandwiched between Katrina and Wilma, recorded claims of $4.7 billion.)

The impact of the storms can be clearly seen with the losses from Bermuda companies such as Montpelier Re, XL and Renaissance, the numbers of which went from merely earnings to capital impact. "Clearly the market is going to want to drive prices up," Mr. Hewitt said.

Those companies facing the sharpest hikes will be reinsurers that were surprised at their catastrophe exposure and did not really price for it, according to Mr. Hewitt. "While it is clear that pricing will increase substantially in the loss-affected classes such as energy and marine, and for U.S. wind cover, the knockout effect on the market overall is unclear," the Benfield report said.

Other factors affecting demand will be the degree to which regulatory and rating agencies set new capital requirements for reinsurers. While new capital can come from the bond and equity markets, most companies would prefer it to come from increased profits, which could make them less willing to sacrifice bottom-line growth for top-line results, Mr. Hewitt said.

At the time of the industry's annual Monte Carlo reinsurance rendezvous in early September, observers there did not see prices rising much higher than they did in the immediate post-9/11 period.

However, the tricky nature of estimating Katrina losses, and the fact that Wilma served as a grim reminder that the hurricane season actually ends on Nov. 30, made those assumptions questionable, Mr. Hewitt said.

New York-based reinsurance intermediary Guy Carpenter Inc. last month put out a "Cedant's Guide to Renewals 2005," which noted that the "highly charged and politicized environment" in the aftermath of Hurricane Katrina will result in the industry working through storm-related issues for years to come. "In general, we believe that property-catastrophe pricing will increase based upon the degree in which the large stock company programs are impacted," the Carpenter report said.

The nature of the Katrina loss could well result in event limits becoming exhausted more quickly than in the past, along with the fact that reinsurers' percentage of retained risk has risen, by some estimates, three- to fourfold since Andrew, the report said.

Finally, with the number of large hotels, casinos and energy facilities suffering damage, there will likely be a reduction of per-risk capacity in the future as risk-retro coverage becomes rare and expensive, the Guy Carpenter report predicted.

Casualty reinsurance pricing might see some firming, if only as a spillover effect. "There may be some writers looking to capture the sharp property price spikes," which "could leave an opportunity in casualty," Mr. Ballentine said.

Other observers have noted that while hurricanes mostly result in property line losses, the sheer magnitude of Katrina's scope could suggest several exposures to casualty insurers, including what has been described as the botched recovery effort.

Mr. Hewitt sees casualty reinsurance pricing as pretty "sticky," with not all that much downside potential. "It is really hard to see how they could cut prices now," he said.

Possible Katrina casualty effects could fall in the workers' compensation line, with injured, displaced workers not having jobs to which they can return. In addition, future health-related claims could come from the so-called "toxic soup" of the New Orleans flood waters.

One of the most critical wild cards in reinsurance pricing is whether Congress will extend the Terrorism Risk Insurance Act of 2002, set to expire at the end of this year.

As this story went to press, it appeared that TRIA would be caught in another down-to-the-wire game of chicken, with the industry's favorite political football–tort reform–making its way into the debate.

All but three states–Florida, Georgia and New York–will allow provisional terrorism exclusions or limitations should Congress fail to extend its federal backstop.

Sean Mooney, writing for Guy Carpenter's "Cedant's Guide to Renewals," warned that "the sunset of TRIA may result in sufficient demand for cover that prices increase dramatically."

The heavy Katrina losses, from a peril with far more sophisticated models than terrorism, will more than likely reinforce reinsurers' inclination to shy away from covering risk where the exposure is relatively unknown, industry observers contend.

"Rating agencies are clearly moving to a more definitive methodology for assessing terror risk in their ratings processes," Mr. Mooney wrote. "The need for insurers to be able to demonstrate that they are managing all types of terror exposure and risks has never been greater."

Flag: Line Breakdown

Head: Premiums Trends Vary By Coverage Class

Caption:

Hurricane losses have reversed the slide in property rates and business income rates, but the market's softening continued in a number of lines.

Flag: Field Breakdown

Head: Premium Trends Vary By Industry Class

Caption:

The energy sector, hit hard by hurricanes, are seeing rate hikes approaching double digits, but the manufacturing and service sectors remain a buyers' markets.

Do Not Run them together==If we can't run both, run Small alone….

"New capital may prevent tightening of underwriting standards that some reinsurance and insurance company managements have been anticipating."

David Small, Analyst

Bear Stearns

"The sunset of TRIA may result in sufficient demand for cover that prices increase dramatically."

Sean Mooney, Senior V.P.

Guy Carpenter & Company