In Florida's Monroe County, regulators turned down a request by Citizens Property Insurance Corp. to raise rates by nearly a third. In response, opponents of the hike and Key West city officials held a parade to mark the occasion. Thus, in certain areas of the country, interest in the reinsurance capacity crunch has gone beyond the usual civic and business realm to encompass marching bands and celebrations in the street.
But Key Westers might have held off on the festivities if they understood the nature of the capacity crisis in their state, where reinsurers have been leaving and Florida is doing its best to pick up the pieces.
Florida regulators and lawmakers are pondering a special legislative session this fall to consider, among other issues, further expansion of access to the state's Hurricane Catastrophe Fund.
In the closing days of the session last May, Florida lawmakers approved a measure to allow smaller-cap carriers with $25 million of surplus or less to buy a $10 million layer of coverage for each of two hurricanes, above a retention of 30 percent of the company's surplus.
In addition, the state has set up a Joint Underwriting Authority to help commercial businesses obtain coverage that primary companies are no longer writing, because reinsurance rates have either gone through the roof or coverage is nonexistent.
Willis Re's Bermuda-based executive vice president, James Kent, noted that pricing has increased between 100 percent and 200 percent over the past year.
Such hefty price hikes prompted many insurers to elevate their attachment point and/or take co-participating positions. "However, increased net participation was not tenable for all companies due to financial constraints–particularly smaller Florida cedants," Mr. Kent noted.
Standard & Poor's analyst Thomas Upton said that if the season turns out to be severe, the catastrophe fund might have to issue additional debt–which would require more emergency assessments to support it, further squeezing the market.
In addition, primary companies might have to settle for lower-rated secondary coverage. "This could have a severe impact on the financial strength of personal insurers with consumer-heavy customer bases, as regulators are less willing to allow personal lines pricing to reflect higher reinsurance costs," Mr. Upton said.
S&P reinsurance analyst Laline Carvalho said primary companies seeking peak-zone coverage have not been able to obtain all they want. "Reinsurers have been very keen on reducing their exposures and improving the way they measure their exposures," she said.
Sidecars and other alternative investments continue to provide extra coverage, "but that has not matched all the needs either, so there is a consensus that there is more demand for capacity than what the market is still providing," she said.
According to the Reinsurance Association of America, hedge funds and private equity firms have pumped $7.3 billion into Bermuda start-up companies and $3.6 billion into sidecars (special-purpose entities through which hedge funds can invest in reinsurers).
One such sidecar that had a spotlight shone on it was Olympus Re, sponsored by Folksamerica Re. Last month, A.M. Best reaffirmed Folksamerica's ratings and upgraded its outlook to stable. But that was after some tense times when 2005 hurricane losses that mounted beyond expectations threatened to wipe out Olympus' capital.
Ms. Carvalho said the main lesson from the experience is that sidecar investors have to understand the volatile nature of the risks they are putting their money into.
A lot of new investors are coming into the marketplace, lured by the promise of high premiums following record 2005 catastrophe losses, but "not all of them fully understand insurance," according to Ms. Carvalho, "and not all of them may be prepared to lose the full amount they put in, because that could happen."
In the end, however, while the new money–which some observers have warned might be transitory–may be substantial, "it is not such a sum that the market will disappear if it disappears," Ms. Carvalho added.
Nonetheless, she noted, the question still lingers: If reinsurers have to go back to the capital markets to replenish up to 40 percent of their capital, "what will happen if the capital markets are no longer there for you?"
Willis Analytics and Solutions' London-based Chief Executive Officer Mark Hvidsten said what he termed the "less feverish" enthusiasm for private placements from hedge funds in the past couple of months could stem from "an increased understanding by both sides of each other's risk and return requirements."
"Clearly, the appeal of catastrophe risk is insufficient to attract the degrees of liquidity that the broad capital markets achieve in other areas," he said.
Thus, reinsurers lowering their exposures today may stem in part from just those kinds of fears. "A lot of these insurance companies are now thinking maybe it is not okay to lose 40 percent of your capital from one event," said Ms. Carvalho.
Even with a fairly benign hurricane season, most experts expect a fairly strong Jan. 1 renewal season. "Not all companies, both primary and secondary, have fully accounted for the changes of RMS 6.0 and what will be their adjusted probable maximum loss figures," she said.
She was referring to the fact that earlier this year, Newark, Calif.-based Risk Management Solutions launched a new hurricane model that increased annualized insurance losses by 40 percent, on average, across the Gulf Coast, Florida and the rest of the Southeast, and up to 30 percent in the mid-Atlantic and Northeast coastal regions.
In addition, the rating agencies have also contributed to higher prices, according to Willis Re's New York-based chairman, Peter Hearn. "Over the last year, all rating agencies have moved to employ substantially more conservative and more stringent parameters to evaluate catastrophe management protocols maintained by insurers and reinsurers," he said.
That means reinsurers face more pressure to reduce accumulations in peak capacity zones–for, among other reasons, a lack of retrocession capacity.
"Additionally, the push for diversity of writings has accelerated the softening in casualty and other less catastrophe correlated markets," Mr. Hearn added.
Along those lines, Jim Bradshaw, a Willis Re executive vice president in New York, said he expects the overall softening and increased competition in the casualty reinsurance market to continue throughout 2006. He said the support given several new casualty start-ups in the first six months of this year could be an indicator of the market's current appetite and future challenges.
"That the majority of these focused on the opportunities within the E&S casualty market speaks volumes to where insurers and cedants believe the greatest potential for underwriting returns reside," Mr. Bradshaw said.
Reinsurers continue to provide capacity for directors and officers primary writers, even with price declines of up to 10 percent in the first six months of this year.
Chip Lalone, a Willis Re executive vice president in Philadelphia, attributed this to a pronounced decline in securities class-action lawsuits. "The wild card for the rest of the year will be the potential impact on the D&O market from options-related claims, which are getting a lot of press lately," he said.
The dollar impact may be difficult to measure at this time, but it has the potential to be significant in a softening market. "Clearly, this issue would be getting more attention from D&O insurers if frequency was not down 45 percent through the first six months of 2006," Mr. Lalone said.
By most measures, the reinsurance industry enjoyed a healthy first half this year. According to figures provided by the Washington-based RAA, while net premium written for the first six months remained essentially flat at $13 billion, the combined ratio improved an impressive nine points to 96.5 from 105.8 in 2005′s first half. (RAA surveys a representative sampling of 23 domestic property-casualty reinsurers each year.)
In July, Morgan Stanley analyst William Wilt said results from XL and Aspen both indicated that reinsurance boosted bottom lines in the second quarter. Current trends could also be seen in XL's "materially shifting portfolio, with professional lines casualty and property premiums up noticeably, largely at the expense of marine/energy premiums," he wrote.
The past year had its comings and goings in terms of reinsurance players.
Last month Bermuda-based PXRE Group Ltd. reported an 82 percent decline for its in-force business after it requested delisting from A.M. Best. CEO Jeffrey Radke said the carrier is seriously considering going into runoff if no "strategic alternative" is found.
On the positive side, Aeolus Re was born with a $500 million capitalization financed by a group led by Warburg Pincus and Arch Capital Group Ltd.
Next year could bring a new regulatory regime to the reinsurance field if the National Association of Insurance Commissioners comes through with its proposal to ease the 100 percent collateral requirements for alien reinsurers by instituting some as yet to be defined ratings system that would apply to all carriers, regardless of country of origin.
Just how this will affect the competitive landscape remains to be seen. The RAA reports that alien and alien-controlled U.S. companies currently command 85 percent of the U.S. market, while the alien share of U.S. unaffiliated premium rose to 52 percent last year.
RAA's senior vice president, Joseph Sieverling, said the figures prove that the current regulatory requirements do not pose all that much of a barrier to free trade in the reinsurance sector.
© Arc, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to TMSalesOperations@arc-network.com. For more information visit Asset & Logo Licensing.