Reinsurance Market Stable, But Cats, Subprime Fallout, Could Stall Pricing Cuts

Meanwhile, another brokerage, Aon Re Global, said it anticipates that the credit and liquidity crisis will mean a slower decrease in reinsurance pricing for Jan. 1, 2009 renewals than otherwise would have been the case had these drags on the market not materialized.

The January renewals will reflect the first time the decline in reinsurance pricing has slowed since the credit crisis began, according to Aon.

Aon predicted that even if significant insured catastrophe losses occur before Jan. 1, 2009, the fast pace of rebuilding capacity will be unprecedented, since the reinsurance and insurance markets are now aligned with sufficient existing and contingent capital providers, such as sidecar reinsurance instruments.

Mr. Zaffino at Guy Carpenter noted that the good underwriting seen so far will require even "more discipline going forward," but agreed that fallout from the subprime mortgage debacle threatens reinsurance market stability.

"Traditionally, major property-catastrophe losses have had the greatest impact on pricing," he said. "But today we're witnessing a new type of catastrophe, and it hasn't found its way all the way through the insurance industry yet–and that is the financial catastrophe around subprime [mortgages]."

This issue could potentially impact "both sides of the balance sheet," he said. "We've seen a lot of challenges in the mark-to-market on the balance sheet, but we have not seen the full implication of how it is going to impact directors and officers and errors and omissions on the insurance side."

This is because there is "a little bit of a lag," he explained. "It's not a real long-tail line, but it certainly takes some time before that manifests."

Christopher Klein, head of Guy Carpenter's global business intelligence unit, added that "storms and subprime can't be ignored, but there also are other factors contributing to pricing trends."

Mr. Klein explained that carriers are continuing to return capital through share buybacks, "extraordinary dividends and things like that. We think that they're tending not to burn it through chasing market share." He said that when faced with the choice of writing cheaper business or withdrawing capacity, many reinsurers are choosing the latter.

"We need to put the credit crisis in perspective, he said. "Yes, it's a significant event, it has brought economic damage, it has affected our industry and it will continue to do so." However, he noted that reinsurance and insurance carriers have "not borne the major brunt of the losses in this–that's been the banks, because they don't manage the same variety of risks that we do."

Mr. Klein emphasized that "reinsurers are in the business of managing risk. It's what we do, so we shouldn't be afraid of it."

To date, for the insurance and reinsurance industries, he said the subprime issue has been "an earnings event–it's not yet a major capital event."

He added that "taking into account all the capital we've lost and all the capital that's come in through recapitalizations, the insurance/reinsurance industry is off by about 6 percent" in the last 14 months, "in terms of capital, whereas the banks are [off] something like 14 percent."

This shows there is "substantially more damage in that particular sector," he said. "We may want to consider what that tells us about the risk management capabilities of our respective sectors."

He emphasized that this shows "insurers have not been brought to their knees, unlike a number of big, brand name banks. There have been significant losses, but there is still plenty of capital available."

He also noted that some of the implications of today's market conditions "won't become clear until the next very large catastrophe," adding that "if the credit crisis persists, and if we have a major shock loss to the industry, we could find ourselves facing a post-loss liquidity crunch."

Mr. Klein said that regarding pricing, "which is always a primary topic here at Monte Carlo, rates have come down throughout the year, and continue to come down–we expect them to continue [to fall] through Jan. 1–but we think they may be below double-digit increases."

The July 1 renewal period saw rates dropping by about 10 percent on average, he said, compared to 6 percent last year.

"There is a general view that reinsurers are being more disciplined about pricing than primary companies," according to Mr. Klein. "Reinsurers have enjoyed several years free of losses and the profitability that comes with that."

Pano Karambelas, vice president and senior analyst at Moody's, reported that the reinsurance outlook remains "stable" for 2009. "The reinsurance industry over the last couple of years has benefited from pretty good pricing, has built up a lot of capital, and balance sheets are such that they can withstand some challenges related to softening of the underwriting cycle," he said.

He added that although prices continue to decline steadily, "they're probably in the neighborhood of what someone would consider to be technically correct rates, depending on the classes of business."

Mr. Karambelas noted that casualty lines are closer to "breakeven," adding that it could be 12-to-18 months before retentions begin to drop.

The other important issue, he said, is holding the line on terms and conditions–which, he noted, is "probably at least as important as the issue of whether you had a rational rate or rate-on-line."

He said that while it's "easy to quantify where you should be in terms of price at the right risk load-in, it's a little bit more difficult to gauge the problems you might be causing yourself down the line with terms and conditions."

Mr. Karambelas also cited the potential impact of the credit crisis.

"The traditional view has it that the reinsurance underwriter cycle is the primary driver of the basic credit conditions of the reinsurance industry," he said. "We've always felt that and we still continue to feel that," while warning that the reinsurance sector has always been exposed to the "broader economy and capital market conditions."

"The reason I mention this now is obvious–that in the last year or so we've seen a lot of turbulence around credit markets and the contagion impact that might have on the U.S. economy," he noted.

In a slowing economy, there also exists the potential for social inflation–the likelihood of not only worsening severity trends but frequency trends due to fraud or "claims that you might see of the economy slows down," he said.

However, Mr. Karambelas warned that the ability to raise capital in a hurry might be waning, giving reinsurers less financial flexibility to react to changes in market conditions or catastrophic events. He said companies have been able to raise capital at will, but that given the state of the credit market, those markets are in turbulence and money could be more costly than in the past.

Mr. Karambelas noted that the securitization market is subject to the same forces, adding that there has been a big drop-off in reinsurance sidecars–separate entities formed by reinsurers to write specific types of business.

He concluded that while reinsurer profitability continues to be strong, it will diminish over the next year in a softening market.

Over at A.M. Best, John Andre, group vice president, recalled that last year was "pretty uneventful. Some said it was the most boring [Monte Carlo] conference."

Now, however, he observed, there have been hurricanes and floods, "and we've seen the equity markets declining sharply, which impacts [reinsurer] results."

Mr. Andre noted that while subprime is an issue to some extent for some reinsurers, "for us, the main question is underwriting. We've seen renewals pretty stable for the first half. The question is, can that continue through 2009?"

Financial results for the first half were stable for the most part, he said.

"We've seen the impact of the market on shareholders' funds because of high interest rates," said Mr. Andre. "Overall, the first-half environment was stable, with the exception of Munich Re, which was hit by large cat claims," including mining and Hurricane Emma.

Mr. Andre said that overall, subprime woes were not an issue for reinsurers, with the exception of Swiss Re, which was "significantly hammered," affecting about 50 percent of last year's profits. "The hit was minimal for most other reinsurers."

Mr. Andre said that through the first half of 2008, Lloyd's results have been "very steady." He called central assets at Lloyd's "very robust," pointing out that the market's "enhanced standards have resulted in a better performance."

He noted that "whether it be a Bermuda reinsurance company or a capital market solution, there is plenty of capacity." Retentions are higher on the cedent side, he said, "and some primary insurers that have also come off of some very solid years may be taking more risk than they anticipated for some weather events."

He pointed out that it is becoming more difficult for reinsurers to "generate the same returns we've seen in the past few years. However, we'll see into 2009 and 2010 whether that same discipline remains as the pressure to improve returns increases."

Peter Grant, an analyst with Standard and Poor's out of London, said that pricing as it stands today is "risk-adequate" as well as "broadly sufficient to enable the industry to earn its cost in capital."

He warned, however, that this "presumes that the relatively benign claims environment that we've seen in the past few years will persist."

He said S&P believes that "for a number of reasons–many of which are related to macro-economic trends–there is a possibility we can expect to see a steep change in claims costs over the next 12-to-24 months."

He pointed out that historically there is a correlation between tightened economic conditions and claims fraud in both the United States and United Kingdom, predicting that economic slowdowns in both countries should put fraud investigators on notice.

While investment market volatility has had a significant impact on the sector from losses in the first half, causing significant capital erosion for the reinsurance sector, Mr. Grant said that in the context of the amount of surplus capital some reinsurers had available, the losses now are very manageable.