Interview with Chris Klein, Director of Reinsurance Market Management
How is the industry doing?
Last year Guy Carpenter & Company, LLC predicted flat or lower pricing at the January 2010 renewal, as an increase in capital out-stripped demand growth, and such was the case. Further erosion of rates was evident throughout 2010 despite above average catastrophe losses during the first half of the year.
The Guy Carpenter Reinsurance Composite indicates that total earnings for the first half of 2010 were down 6.4 percent to USD4.8 billion compared with 2009. The principal driver was an underwriting loss of USD901 million, compared with profit of USD2.4 billion last year. Much higher catastrophe losses in 2010, estimated at USD22 billion for the insurance and reinsurance sector, had a major impact with substantial losses from the Chile earthquake, Windstorm Xynthia and the Deepwater Horizon rig. However, the underwriting deficit would have been much worse but for the continued mitigation from prior years’ loss reserve releases and realized investment gains of USD2.5 billion, compared with losses of USD1.5 billion in 2009.
Source: Guy Carpenter & Company, LLC
Return on equity also rose because shareholders’ funds decreased. Shareholders’ funds stood at USD108.8 billion at June 30, 2010. An increase in shareholders’ funds from retained earnings and the unrealized increase in asset values were offset by share buy-backs, dividends and currency effects. Guy Carpenter estimates that the reinsurance sector held excess capital of approximately 8 percent at the end of the first half of 2010.
What has this meant for market conditions?
At the July 2010 renewal, Guy Carpenter observed risk-adjusted price decreases in the range of 10-15 percent for the important U.S. property catastrophe renewal. A recent study of Guy Carpenter’s U.S. nationwide property catastrophe renewals throughout 2010 revealed that the total sum of authorized lines in 2010 was 38 percent higher than the total of 2009’s expiring authorized lines. Average signing rates were reported at 84 percent in 2010 compared with 94 percent in 2009.
U.S. casualty lines continued to show soft pricing. Capacity for international casualty was plentiful, reflecting over-capitalization and new entrants to the market. Any price increases were mainly due to specific loss experience.
Where do we expect the market to go?
The answer, as always, is, it depends. Several underwriters have either exhausted or expended a substantial portion of their 2010 catastrophe loss budgets. This might lead to spot purchasing of reinsurance or retrocession to cap losses before the end of the year. More broadly, absent a market changing event, we expect the market to continue to drift downwards, except where there has been meaningful loss experience.
Factors that could put upwards pressure on pricing continue to lurk in the wings. Support from reserve releases appears to be waning and our analysis of statutory data for the U.S. property/casualty industry already reveals modest adverse development for the 2008 accident year in 2009. Investment returns remain low, aggravated by bigger holdings of cash on balance sheets, while, in some countries, the threat of inflation is growing. Regulatory initiatives such as Solvency II also threaten to increase the cost of capital. This could provide the stimuli for rising prices to cover the increased cost of capital and increased demand for reinsurance that can provide relatively simple and quick relief against higher capital costs.
Meanwhile, reinsurers have responded to excess capacity through consolidation and active capital management. They have tried to increase leverage through dividends, share buy-backs and substitutions with cheaper debt. While these measures might provide immediate relief to managements under pressure to maintain returns, are they what shareholders really want, especially those of a longer term disposition? Is there some alternative means that would generate adequate returns, keep capital in the industry and not burden shareholders with the problem of finding satisfactory investments elsewhere? Reinsurers may need to address these questions and explore the options that lie in the answers.