Cat Re Capacity Shrinks For Key Areas

Shrinking reinsurance capacity prompted primary insurers to shed more exposures from already trimmed-down property books, as well as restructure underlying insurance policies–a process they expect to go on into next year, he and other experts said.

David Duffy, a managing director for New York-based Guy Carpenter, said insurers "are making some tough decisions."

"The smart insurers are going to look to manage down their cat exposures, independent of just going to the reinsurance market and buying increased limits each year," he said. "There's a limit to what many companies can spend on cat reinsurance."

Rates soared for midyear property renewals–for some cedents by 100 percent–creating conditions longtime participants said were historically unparalleled.

Following the events of last year, everyone expected a hard reinsurance market, Don Kramer, chairman and chief executive officer of Bermuda-based Ariel Re, told NU. However, "a lot of the [storm loss] reporting came out after Jan. 1–after renewals were booked"–creating harder conditions as the year progressed, he noted.

To Mr. Thaler, it wasn't surprising that the full impact of last year's hurricanes wasn't felt on Jan. 1. He noted that large August or September hurricanes–such as Alicia in 1983 and Andrew in 1992–typically don't push catastrophe reinsurance pricing up dramatically until the second- or third quarter of the following year.

Both Mr. Kramer and Mr. Thaler suggested that May releases of revised vendor models, pressure from rating agencies, withering capacity in the property-retrocessional market and softer market conditions outside the United States all conspired to create more dramatic midyear changes than history would have predicted.

"It was almost as if at March 15 someone turned the switch and the market was tighter than a drum," Mr. Thaler said, speaking at the Casualty Actuarial Society's Seminar on Reinsurance in early June.

That "someone" may have been the rating agencies, he suggested later. "It seemed like they had 'come to Jesus' conversations with some reinsurers, where they took them aside and said show me your aggregates; show me your business plans," he said.

"They gave [reinsurers] a choice–raise more capital or cut your aggregates," he continued, adding that it was during the last week in March and early April when brokers sensed these conversations took place.

"The markets almost dried up completely" in Florida and Gulf Coast regions, Mr. Kramer said. "In fact, on July renewals, some incumbents on [reinsurance] programs actually got off them," he noted, explaining that when they reassessed what they'd booked on Jan. 1, and coupled that with new rating agency requirements, they found they were overextended.

"As we come up to July, rates are the hardest I've ever seen for affected areas," he said in late June, surpassing rates that prevailed after Andrew "by far."

"And the carryover to 2007 seems relatively assured" as reinsurers try to "shed volatile lines in response to rating agency pressures that didn't exist" right after Andrew, he said.

Mr. Thaler noted that while U.S. pricing for property business is soaring, pricing has been flat outside the United States–another condition setting the 2006 property reinsurance market apart. With pricing very firm around the world in 1993, reinsurers were able to spread risk, diffusing the impact on U.S. pricing and enabling them to maintain or increase aggregates in the face of sharply increased worldwide cat pricing.

While better worldwide pricing might have brought U.S. hikes down, Mr. Duffy noted that capacity issues would remain. "I don't think it frees up additional aggregate in the United States. [Reinsurers] still have to deal with hard aggregate caps in Florida and on the Gulf Coast"–self-imposed and external caps imposed by rating agencies.

In contrast, when RenaissanceRe and MidOcean started up in Bermuda in 1993, they were flying under rating agency radar screens, Mr. Thaler said. "Those companies made some significant bets in the United States–and won," he said.

Steven Bolland, president of reinsurance intermediary Gill and Roeser in New York, said the midyear market "falls into two distinct camps–business related to property cat, and everything else."

"Everything else was very stable and normal, with not much change," he said. But for any and all lines relating to property-catastrophe, "people were surprised by the extent of what happened," he added, putting the magnitude of price increases "at least twice what they were at Jan. 1, on average."

For Jan. 1, reinsurers said they expected average property-cat price increases of about 30 percent, and "they probably got pretty close," so for July 1, year-on-year increases are probably 50-to-60 percent, he said.

That's average, he noted. Insurers that didn't have bad experience in 2005 in certain regions were almost flat, "but for those areas significantly impacted by the losses in the last year or two, it wasn't unusual to see 100 percent increases," he said.

"It's a question of how high can you push certain areas," he said. "Would you want to write in Florida?"

At the June CAS seminar, Mr. Thaler said pricing in Florida was up 125 percent over 2005, and nationwide programs faced 50-to-100 percent price jumps, or more–on top of retention increases and coverage restrictions. "That's real. I'm not speculating on that." Even cat-exposed regional insurers saw 25-to-50 percent hikes, he said.

Mr. Bolland said the majority of insurers, even those with Florida-only books, were able to complete their reinsurance programs at midyear. "There is capacity available at the right price," he said.

"Interestingly, after the Jan. 1 renewals, there was a general feeling that too much capital had come into the cat reinsurance market," with some new Bermuda companies saying they fell short of Jan. 1 premium targets. "July showed the reverse might be true. Prices are still going up, and there's a capacity shortage. You're actually chasing capacity with money," he said.

Speaking at the CAS seminar, Mr. Thaler said that "because [reinsurers] have so little scarce aggregate available, they're looking to maximize" the pricing they can get. "We should advise our clients, as brokers, to buy as little reinsurance as they can afford," he continued, delivering the unusual advice as a way to emphasize a broker's role in helping clients restructure reinsurance programs, to consider alternatives such as cat bonds, and to simply start "drilling down" and paying more attention to risk management.

Giving an example of how high prices can go, he said that while rates-on-line (premium-to-limit ratios) for nationwide cat programs now range from 17.5-to-25 percent, there have been more instances of average program rates-on-line approaching or exceeding 30 percent.

"How do you know?" Mr. Bolland responded when asked whether prices had risen to adequate levels.

"For 20- or 30 years, you've been hearing reinsurers ask, 'How do you price U.S. casualty business?' given how difficult it is to get a handle on what courts are going to do or how asbestos claims will play out. But if you listened to executives of White Mountains on a conference call recently, they were asking, 'How can you know the ultimate cost of property-cat business?'" Mr. Bolland reported. "They said they were seduced" into writing too much property business at high prices, "only to find prices weren't high enough." (See related story, page 19.)

Price adequacy hinges on answers to scientific questions about whether warm sea temperatures are fueling more severe storm seasons. Beyond that, there are issues such as late loss development, Mr. Bolland said, referring to $200 million of energy losses that White Mountains just found out about.

"These are huge accounts. I can't believe Folksamerica [White Mountains' reinsurer] would have more than 5-to-10 percent" of the impacted treaties, he said. That would mean "there's another $1.8 billion wandering around. That's a big number. Why is nobody talking about it?"

Mr. Bolland said there will likely be more price hikes for Jan. 1, 2007 to reflect elevated frequency and severity assumptions of vendor catastrophe model revisions that didn't find their way into some Jan. 1, 2006 renewals.

"I would expect, absent a major U.S. hurricane this year, or another significant disaster, that Jan. 1 reinsurance pricing would catch up with midyear," he said. But there also might be a little bit of softening, "because if nothing happens, people will make a lot of money based on current pricing, and they'll have a lot more capital."

Comparing the likely fate of an insurer with a Jan. 1, 2006 renewal that got a 20 percent price increase with competitors with July 1 renewal dates that saw 50 percent jumps, he said "the Jan. 1 guy might not see 30 percent" next year, predicting 10-to-20 percent instead. "That's if nothing happens. All bets are off if there's a loss."

Mr. Thaler sees some positive factors influencing next year's market conditions, even if a Katrina-sized loss should recur in 2006. Highlighting portfolio changes that reinsurers have made, for example, he predicted a Katrina repeat would produce an earnings impact, not a surplus loss.

He said reinsurers cut "as-if" Katrina-like exposures probably by about one-third, raised property pricing 50-to-100 percent, and slashed aggregate exposures around 40 percent for peak zones. In addition, he said reinsurers cut back on excess-and-surplus business in their direct and facultative books, where outsized 2005 hurricane losses to casinos and other major properties damaged portfolios that previously had no losses.

Such cuts have prompted insurer actions that will ultimately improve reinsurer results, he said. Insurers are "focused religiously on risk management." They're taking much bigger retentions, he added, noting that he's seen 50-to-100 percent increases in attachments for catastrophe reinsurance.

Mark Haushill, chief financial officer of Argonaut Insurance Group, said reinsurance capacity and cost issues are significant enough to make the specialty insurer rethink its exposure to coastal areas.

Speaking at Standard & Poor's annual insurance conference in early June, Mr. Haushill said that while insurance rates this year are much higher for property risks written in its E&S business units, "we're not sure that those risks are at the right rate [levels] relative to the capital we have to hold and the reinsurance" costs.

When Argonaut's reinsurance program came up for renewal on May 1, "capacity was different than what we thought," he said. "We are evaluating our risks relative to aggregates, relative to reinsurance capacity, and determining whether or not we think this is an efficient use of capital," he said.

In a follow-up interview, he noted that because Argonaut is a casualty-driven company, with less than 20 percent of its business in property, it "may have had a different experience" than property insurers. "We were in an awkward spot relative to the timing," he added, noting that the cat models had just been released.

"But we were able to execute the program we needed. It wasn't easy. It was a complex, arduous process," he said, noting that Argonaut ultimately obtained more coverage this year, albeit at a higher price. (Details will be included in Argonaut's second-quarter public filing.)

As for changes in Argonaut's book, he said, "there are certain types of construction we are no longer underwriting." The company is avoiding frame, for example, "and I think we're seeing a better class of risk on the E&S side than…in prior years."

Mr. Thaler noted that insurers are also transferring more exposure back to insureds through higher wind deductibles. "We're looking at 5 percent of total-insured value" on large commercial industrial property accounts, which can be significant dollar amounts ($25-to-$50 million deductibles).

All experts said that while rating agency analyses will include qualitative reviews of enterprise risk management going forward, they don't believe reinsurers have a prayer that rating firms will lower capital charges. Indeed, some noted that negative votes on monoline-property business models from rating firms had pushed some reinsurers toward more casualty business.

But memories of huge casualty loss developments over the past 20 years are still vivid, according to Mr. Bolland, who concluded that reinsurers wouldn't suddenly start slashing casualty prices.

While market participants, for the most part, saw discipline on both the property and casualty sides of the market, some said large European reinsurers are a market wildcard. "There are companies that are so intent on maintaining market share [that] they seem to be pushing to maintain the status quo when prudence might suggest that a closer look at exposures and price adequacy might be warranted," Mr. Thaler said.

Anticipating hard market conditions again in 2007, "we've already had brokers come in to talk to us about '07, and we haven't even seen '06 results yet," Mr. Kramer noted.

Mr. Duffy said his firm expects to use what might otherwise be lazy summer months to find ways to bring additional capacity to the cat market and to help clients better understand their exposures.

Assisting with the second goal, Guy Carpenter has unveiled a suite of tools called I-aXs, which allows insurers to work with their exposure data online so they can see the implications of changing deductibles or limits profiles in certain parts of the country.

Accomplishing the first goal–finding more cat capacity–will entail looking at "absolutely everything," including working with Guy Carpenter specialists in cat-linked securities, according to Mr. Duffy. "That's really a blank sheet of paper right now," he said, noting that solutions could come from within the industry or other parts of the financial community.

Might the possible solutions include investing in a start-up reinsurer? "Honestly, we're not focused on any particular solution," he said. "We're literally going to have a blue-sky meeting right after July 1 to throw out ideas…I don't think any decision's been made about what the best route would be."

Art caption: