October 25th, 2010

Dark Clouds Ahead? Factors Influencing the European Rate Environment

Posted at 1:00 AM ET

frankland_nick_gcciNick Frankland, CEO of European Operations

The first renewal of 2011 is right around the corner, and as always at this time of year, the sport of reinsurance rate forecasting has begun. It is an uncertain exercise, of course, as a late-year mega-catastrophe could change the market almost immediately, but given today’s rate environment in Europe, it looks like the new year will bring another cedant-advantaged renewal. Capital is abundant across the industry, as (re)insurers have endured an active catastrophe year with help from reserve releases and investment gains.

Much has changed in the two years since the September 2008 financial crisis. A measured rate increase at the January 1, 2009 renewal indicated that (re)insurers had sufficient capital to endure the event. Throughout the year that followed, European carriers were able to rebuild their balance sheets, setting the stage for a return to reinsurance rate reductions in 2010. Since rate increases last year only reached 2007 levels, this year’s declines represent a return to early 2008 market conditions, in which excess capital resulted in favorable pricing for cedants.

European property-catastrophe rates undoubtedly will be affected by the heavy catastrophe losses in 2010. Much of the activity came in the first quarter, from the earthquake in Chile and Windstorm Xynthia, with the Deepwater Horizon event contributing in the second and third quarters. In all, total (re)insurance catastrophe losses have reached an estimated USD22 billion this year, with the Guy Carpenter Global Reinsurance Composite sustaining a loss of USD6.1 billion.

Yet in Europe, as in the rest of the world, the year’s catastrophe events have not been sufficient to turn the market. As in 2007 and early 2008, (re)insurer capital has been sufficient to absorb the ensuing losses. After spending 2009 recapitalizing, the industry entered 2010 with strong balance sheets, which were able to handle the shocks that occurred throughout the year. Thanks to recovering capital markets, investment gains compensated for underwriting losses, though some support did come from reserve releases - a source that is inherently constrained.

Despite the tension between catastrophe losses and investment gains and reserve releases, the (re)insurance industry is heading into the next renewal with robust balance sheets, a clear signal that property-catastrophe reinsurance rates will decline. Doubtless, actual changes in rates will depend on specific program performance, capital availability for particular risks and regions and demand for reinsurance protection. In fact, with capital held by primary insurers having increased, too, retentions are likely to increase - translating to less demand for reinsurance and further pressure on rates.

Of course, there are many factors in Europe that could alter the outcome of the January 1, 2011 reinsurance renewal. A market-turning catastrophe event before the end of the year could drive rates higher, and as we saw two years ago, economic factors also could be sufficient to affect rates. Investment returns and capital availability will be impacted by inflation, for example, along with other shifts in monetary policy. Sans a crystal ball, it is impossible to predict where rates will land, but all indicators point to a continuation of the existing trend.

An abundance of capital has created an environment favorable to cedants, but this should not be allowed to lead to complacency. Market conditions can change quickly, and being caught without sufficient protection from the unexpected can have dire consequences for firm value. There is still enough economic uncertainty in Europe, especially with a history of quantitative easing and expected inflation, to make comprehensive capital management crucial. Significant balance sheet changes can impact reserves and result in exposure: there’s no substitute for protecting against a wide range of risks, even when retention seems easier.

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