October 25th, 2010

U.S. Property Cat Rates and Opportunities for Making Excess Capital Productive

Posted at 5:00 AM ET

mckeown_christopher_bioChris McKeown, President & CEO of North America Broking Operations

It feels like 2007 all over again. Following contained increases in the United States in 2009, property-catastrophe reinsurance rates fell again in 2010, continuing a trend that has been the norm since Hurricanes Katrina, Rita and Wilma struck in 2005. Low levels of catastrophe losses, abundant capital at attainable prices (generally) and advances in risk and capital management practices are some of the main reasons why rates have generally fallen. Even when they did increase in 2009, influenced by the 2008 financial crisis and Hurricane Ike, they did not skyrocket.

In fact, the industry demonstrated that it could absorb simultaneous physical and financial catastrophe losses with subsequent reinsurance rate increases that didn’t compare to those triggered by the 2005 hurricanes, let alone the post-Hurricane Andrew renewal.

Because of the measured rate increases in 2009 and the reductions this year, 2010 does look a lot like 2007. (Re)insurer balance sheets are not only sufficiently stocked, but “excess capital” is weighing them down. Without opportunities to make it productive, this capital constrains return on equity, making it difficult for carriers to hit target levels. Historically, the solution has been to return the excess to shareholders, either through dividends, where it is returned “permanently,” or more “temporarily” through share buybacks. Share buybacks can also create a “warehousing” situation, as the shares can be retained as treasury stock to be re-issued at a later date. Also, there are a number of methods of stock repurchase in the United States: open market, private negotiations, repurchase ‘put’ rights, and two variants of self-tender repurchase: a fixed price tender offer and a Dutch auction. If the similarities to 2007 hold, we’ll likely see capital returned next year (as we did in 2008). Share repurchases have become a very popular capital management tool in the last decade, although not for everyone.

There are other options. Returning capital to shareholders effectively means surrendering an opportunity to generate returns. Instead, (re)insurers should look for ways to turn excess capital into investments in profitable growth. New markets, mergers and acquisitions, strategic alliances, emerging risks and innovation provide plenty of opportunities, but the entire process begins with prudent and disciplined capital modeling.

Improvements in capital allocation create business opportunities that would remain elusive otherwise. Careful modeling, scenario evaluation and comparison against the company’s risk profile, appetite and tolerance will determine where capital should be invested for optimal results. The Guy Carpenter & Company MetaRisk® platform allows a thorough analysis of the alternatives and identifies the value-accretive allocations that will fuel revenue, profit and market share growth - and increase shareholder wealth.

Further, MetaRisk allows exploration of new products, market entry plans and emerging risks. Rather than proceed with insufficient information - which can lead to the extremes of conservatism or recklessness - users can evaluate the marginal impact of these strategies on the company as a whole, driving prudent decision-making. Microinsurance, emerging markets and other relatively new risks thus can be integrated into the portfolio in a way that balances profit and loss potential relative to the company’s financial objectives.

Excess capital represents an opportunity. Invest it effectively, and it becomes a tool for moving ahead of the competition. The key to doing so effectively is reliable and thorough capital modeling. MetaRisk allows examination of the wide range of alternatives available - beyond returning capital to shareholders - so companies can allocate capital appropriately for risk profile and growth objectives.

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