September 7th, 2009

Stability Returns

Posted at 6:01 AM ET

zaffino_013_croppedPeter Zaffino, President and CEO

Last year the conversations at Monte Carlo were driven by a mixture of factors. Reinsurance pricing was decreasing in response to the reduced loss activity. Capital was being returned to shareholders as reinsurers withdrew capacity rather than accept terms that did not meet their own internal hurdle rates. Concerns were growing about the implications of the unfolding global financial crisis and whether the problems that had affected the banks would have a material impact on the insurance and reinsurance industry.

Within a few weeks sentiment changed dramatically as Hurricane Ike struck, investment markets plunged and capital markets closed. Anxious reinsurance buyers, especially those with hard-hit balance sheets, worried about the availability of capacity at affordable prices, while reinsurers were concerned about their ability in the event of a large catastrophe loss to replenish balance sheets from frozen capital markets. Predictions of sharp increases in reinsurance prices replaced those of a general decline that had prevailed at Monte Carlo.

The price spikes many had forecasted for the 2009 renewals did not occur. Global property-catastrophe prices rose by 8 percent on average, while increases in the United States, which bore the brunt of the hurricane losses, were in the range of 10 percent to 15 percent. Expectations of higher increases were unfulfilled as the laws of supply and demand established the new pricing equilibrium. Demand increased but was muted because damage to cedents’ balance sheets was not universally severe.

On the supply side, reinsurance capacity was depleted, but not devastatingly so. The Guy Carpenter Global Reinsurance Composite sustained an 18 percent decrease in aggregate shareholders’ equity, but reinsurers absorbed the shocks to their balance sheets from hurricanes and investment losses. They continued trading without government assistance, and only one minor reinsurer failed in 2008. Reinsurance capital played well in its role during these challenging economic times.

Looking ahead at the reinsurance market conditions for the 2010 renewals, several factors suggest that upwards pricing momentum may continue. Investment returns remain relatively low, putting pressure on underwriters to maintain or increase margins. Releases from prior years’ loss reserves that have supported earnings in 2008 and 2009 are finite, and accident year loss ratios are starting to rise. The rating agencies are raising expectations for pricing, returns and reduced volatility. Reinsurers’ balance sheets, while of adequate strength, have less room for maneuvre than at the beginning of 2008.

Nevertheless, the market appears to be stabilizing. Fears of a capital famine have eased as investment market volatility decreases and interest rates are at very low levels. Balance sheets are recovering with the restoration of investment losses and low catastrophe losses in the first half of 2009. Indeed, some companies are continuing to buy back shares since capacity is adequate and demand is, in the short term at least, constrained by the effects of recession. A further factor is the increasingly generic nature of the reinsurance market as credit ratings are squeezed into a narrower, mostly single A range, making it harder for reinsurers to distinguish themselves and easier for cedants to diversify.

At Guy Carpenter, we expect a stable market at January 1, 2010. Although, should catastrophe activity remain calm, reinsurers’ balance sheets could end 2009 having recovered a significant proportion of their 2008 losses and capacity would then be ample. Of course, when making forecasts at this time of year, this could change very quickly should a major catastrophe loss or financial shock occur. In the meantime, cedents and reinsurers certainly have less interesting topics to discuss than a year ago.

Guy Carpenter & Company, LLC provides this text for general information only. The information contained herein is based on sources we believe reliable, but we do not guarantee its accuracy, and it should be understood to be general insurance/reinsurance information only.

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