December 30th, 2010

Global Reinsurance Outlook: Points of Inflection, Positioning for Change in a Challenging Market: Executive Summary

Posted at 1:00 AM ET

141x141jan1thumb2011 Renewal Rates Reflect Continued Softening

Early predictions that January 1, 2011 reinsurance renewal rates were likely to fall have been proven correct. The Guy Carpenter Global Property Catastrophe Rate on Line (ROL) Index lost 7.5 percent - the second consecutive annual decline. Contributing to this move has been a combination of factors, including moderate loss activity and abundant levels of industry surplus.

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The decline in rates on line at January 1, 2011 takes place following a year that began with significant catastrophe activity. Losses in the first half of the year were well above average and included Windstorm Xynthia, the Deepwater Horizon oil rig loss and the Chile earthquake. However, despite the New Zealand earthquake in the second half, the year finished with relatively low insured catastrophe losses - owing in large part to an unexpectedly low-loss hurricane season. Subdued losses, combined with unrealized investment gains, led to record levels of capital, which in turn drove reinsurance pricing lower at the renewal. Structures have not changed significantly: Cedents are buying similar amounts of cover to last year, with purchasing appetite helped by attractive pricing.

As shown in Table 1, 2011 renewal rates varied widely by business segment - yet most trended overall flat to negative to their levels last year. The only sectors with a clear upward bias were Marine & Energy and Credit, Bond & Political Risk.

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Outlook 2011: Identifying Forces for Change

While soft market conditions show no immediate signs of reversing, we note an increasing number of latent factors which - alone or in combination - could at some point precipitate a meaningful change in the market’s direction. Depending on loss experience, these factors could begin to coalesce around renewals later in the year.

As always, a major catastrophic event of sufficient size could reverse the direction of rates. We estimate that a USD50 billion insured loss event would stem the decline of property catastrophe reinsurance rates for at least one year in the current, capital rich environment. At USD100 billion, we believe “outlier” reinsurance entity failures could occur, while a USD150 billion insured loss event would create a decided and sustained market turn.

Reserves also bear watching. As reserve releases continue unabated, we question whether the sector has entered the ‘cheating phase’ and how much longer favorable development can be expected to prop up calendar year results.

US P&C sector underwriting cash flow has also turned marginally negative, and we note that the last hard market was accompanied by significant underwriting cash flow shortfalls.

Finally, persistent low sector valuations could themselves prove to be a catalyst for change by precipitating industry consolidation in the form of share repurchases and increasing the potential for mergers and acquisitions (M&A) - both of which could serve ultimately to restrict the supply of reinsurance capital.

It is not clear which of these factors will emerge to affect the direction of the industry, in what combination or when. But there are enough potential catalysts to serve as a potent reminder that the status quo in the industry is not permanent.

Industry Grapples with Regulatory Changes

While the direction of the reinsurance industry in 2011 is uncertain, it is very clear that regulatory issues will be high on the agenda of virtually every participant. At the top of the list is Solvency II, which is set to be implemented in 2013. While nominally European in scope, it is sure to have a significant impact on the entire global industry for years to come.

We note that Solvency II is not only a change in risk management practices but also in management information systems - with a substantial burden resulting from documentation, transparency and disclosure requirements. As a result, the resource costs associated with Solvency II’s implementation are putting significant pressure on companies at a time when market conditions and underwriting results are less than optimal. Smaller companies and niche players will be most at risk, and it is crucial that these companies take the right steps now to optimize their performance under the new regime.

Other issues we expect to loom large among reinsurers and the insurance industry in the year ahead include a potentially busy hurricane season and a continued focus on developing and obtaining terrorism risk transfer mechanisms. With regard to hurricane risk, Colorado State University is calling for an above-average hurricane season for the sixth year in a row with 17 named storms, nine hurricanes and five major hurricanes predicted.

In all, we expect 2011 to be a challenging year both in terms of the underwriting environment and underlying macroeconomic issues. But it is also likely to be a year of opportunity, particularly if we see catalysts emerge that begin to change market fundamentals. In any case, firms armed with the best insight, tools and analysis will be those most prepared to position themselves for the inevitable changes to come.

The report is available exclusively to Guy Carpenter clients. Clients are encouraged to contact their Guy Carpenter broker to receive a copy of the report.

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