December 17th, 2009

Cash and Capital: An Abundance of Choice

Posted at 1:00 AM ET

booth_richard_bioRichard Booth, Vice Chairman
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Cash and capital have returned to the (re)insurance industry. Despite the severity of last year’s financial crisis, the discipline that helped carriers persevere has become the foundation for recovery — and a plethora of strategic alternatives. Balance sheets have improved, and cash positions have surged. This remarkable change of circumstance will certainly have a substantial impact on the coming reinsurance renewal. Rates are likely to remain flat at January 1, 2010, thanks to stronger capital positions across the industry. Even with last year’s price increases, we are unlikely to see rates return to 2007 levels.

Through the first half of 2009, the balance sheets of reinsurers recovered. Less than a year after the financial crisis drained reinsurers of 18 percent of their capital, according to the Guy Carpenter Global Reinsurance Composite, signs of recovery are evident. At the midpoint of 2009, shareholders’ equity was up 8.2 percent, mostly due to an improvement in investment asset value increases and strong underwriting results.

The earnings of the Global Reinsurance Composite swung from an aggregate loss of USD3.5 billion at the end of 2008 to a gain of USD4.6 billion through the first six months of 2009. Capital inflows from outside sources (such as issuing securities) were relatively low, with only isolated instances in the first half of the year. Capital is coming back as a result of milder loss activity and the recovery of asset values, among other reasons. As financial markets continue to stabilize, the likelihood of outside capital flowing into the industry increases. For now, though, carriers have taken charge of their own financial recoveries, with compelling results.

The cash and cash equivalents held by (re)insurers has increased alongside shareholders’ equity. For the first half of 2008, cash positions for the Global Reinsurance Composite increased an aggregate USD1.9 billion. The Global Reinsurance Composite saw this measure grow an aggregate USD7.9 billion — skyrocketing 316 percent year-over-year. The result is a position of strength regarding strategic alternatives, as cash entails flexibility, which is likely to be supplemented by the ongoing thawing of capital markets. Cash and capital bring choices to (re)insurers, and a broad array of choices translates to opportunities to create value.

Disciplined capital management and a flat renewal will require that (re)insurers find ways to make their capital more productive next year. Though talks of dividend payments and share buybacks have already begun, many carriers are building acquisition agendas, and the amount of activity in this space is poised to spike over the next few years — doubtless fueled by the substantial cash holdings now commonplace in the (re)insurance industry. A sense is emerging that some carriers will have to acquire or be acquired over the next two years, as a mature and competitive industry’s participants seek any edge they can find.

Of course, memories of the financial crisis have not begun to fade yet, and the value of having seemingly extra capital on the balance sheet is likely to be the enduring lesson of the events of 2008. After all, it was the “excess capital” positions with which (re)insurers entered the year that helped them absorb the September shocks that followed.

Further, (re)insurers may have to deal with a more expensive cost of doing business as a result of rating agency and regulator demand for more capital to be held. Balance sheets will be less geared, making it more difficult to generate high returns on capital. The key question for January 1, 2010 and the year to follow, therefore, is whether reinsurers will be able to pass on this higher cost of capital to cedents. History suggests that this is not usually the case.

Though strategic decisions will abound in 2010, the first renewal of the year is foremost in every mind in the (re)insurance business. Larger balance sheets and robust cash positions will undoubtedly play an important role in the coming renewal, preventing a second consecutive year of reinsurance rate increases. The up-tick in capital may lead to another up-tick in capital — if the industry continues to be profitable — resulting in further increases in shareholders’ equity and therefore expanding the growth opportunities open to our industry. Market share will follow careful analysis and prudent decisions, rewarding those who maximize the productivity of their balance sheets.

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