David Priebe, Chairman of Global Client Development
A tumultuous market is beginning to show signs of calm. After more than nine months of financial market volatility — and uncertainty as to reinsurance rates — we are looking back on three relatively stable renewals and a full quarter of financial results. Many forecasted the worst last September, and now, we’re seeing that insurers and reinsurers have been able to adapt to a capital-constrained environment. Slowly, earnings are recovering, and capital is becoming available — both of which are keeping reinsurance rate increases under control. This is the result, however, of a precarious balance between supply and demand, one which could be disrupted by a shock to the marketplace.
Each of the year’s major renewals — January 1, April 1, and June 1 — was accompanied by calls for rate hikes of 20 percent or more. Anxiety was abundant, as cedents headed into these renewals unsure of where the final cost to transfer risk would land. Almost uniformly, these fears did not materialize. The global trend for property-catastrophe reinsurance rates ranged from 10 percent to 15 percent, with slight differences driven by program-specific factors such as loss history, region, and line of business. Capital has proved to be available, though not to the extent that it had been a year earlier. Nonetheless, the business of risk transfer was able to proceed as one would expect: price increases were reasonable, given broader market conditions.
Reinsurer balance sheets held the explanation for a year of rate increases that have really only returned risk-transfer pricing roughly to 2007 levels. The widespread loss of capital that occurred in 2008 did not continue into 2009, and even the balance sheet damage that occurred last year wasn’t comparable to the hard cash payouts following Hurricanes Katrina, Rita, and Wilma. According to the Guy Carpenter Global Reinsurance Composite, shareholders’ equity increased 4.6 percent in aggregate, relative to the fourth quarter of 2008, suggesting that a sense of stability has taken hold. A rush to optimism, however, would be imprudent. Adjusted for reserve releases and the reclassification and revaluation of securities, shareholders’ equity is up only 1.4 percent quarter-over-quarter. Nothing lost, nothing gained — the market seems reluctant to choose a direction.
This is the precarious balance that has caused reinsurance rates to increase without skyrocketing.
Carriers are trying to raise capital, therefore, but progress has been slow. Conditions have continued to ease through the second quarter of 2009, with some companies successfully raising debt and equity capital, though it has not been cheap. Consequently, carriers can begin to replenish their balance sheets, as long as they are willing to pay a premium to do so. Widespread capital-raising of a magnitude to undo the damage of 2008, however, is extremely unlikely. For the foreseeable future, gains will be modest.
Nonetheless, there are reasons to be optimistic. Though conditions are still in place to push prices higher — particularly because of shriveled investment returns, relative capital scarcity (or the perception, at least), and the cost of replenishment capital — this hasn’t happened. And, income statements and balance sheets indicate the potential for improvement.
Reinsurer net losses from the first quarter of 2008 to the first quarter of 2009 have shrunk by 86 percent. The Global Reinsurance Composite’s unrealized losses have fallen from USD5.3 billion to USD3.2 billion for the same period — a favorable turn of 39 percent. Excluding the distorting effects of a few large reinsurers, net losses were fairly flat, and realized and unrealized investment losses are more favorable. Further, the Global Reinsurance Composite posted an aggregate non-life underwriting profit of 60 percent for the first quarter of 2009 (year-over-year). The frequent and severe large per risk losses at the beginning of 2008 did not occur this year, and reinsurers benefited from the release of prior years’ loss reserves.
The earnings upturn suggests that financial markets may be loosening, but the balance remains tenuous. A severe shock could result in a dramatic turn in the market, bringing back the pessimistic forecasts of late 2008. Another round of negative financial disclosures or an unexpectedly brutal hurricane could lead to calamity. On the other hand, positive results for the second quarter would constitute an implicit vote for the start of a market recovery. Absent either outcome, rates are likely to continue to increase in the 10 percent to 15 percent range, while cedents and markets wait for a set of market forces to prevail.
In a month, our attention will turn to Monte Carlo, effectively the kickoff of the next renewal season. It’s pretty easy to see the market’s direction … as long as nothing happens. Absent a stiff breeze from financial markets or the gusts of a hurricane, little is likely to change. Positive developments, if they occur, are likely to be slow and cautious. For now, though, all is quiet, and everyone is watching.
Originally published in Reinsurance magazine