Global Reinsurance Review January 2009

Reinsurance rate increases were moderate on average at the January 1, 2009 renewal. The Guy Carpenter World Rate on Line (ROL) Index rose 8 percent, in response to the dual pressures of a financial catastrophe and the second most expensive property catastrophe year on record. The degree to which prices increased was tempered by large capital positions at the beginning of 2008, enabling carriers to absorb the year’s losses, but this is where the generalizations end. Loss history, geography, and line of business led to wide differences in pricing. Expectations of another above-average storm year and the uncertainty surrounding the credit crisis underscore the need for continued capital management discipline in the coming year.

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Most catastrophe bond issuance activity has addressed natural catastrophe exposures in Japan. Since 1997, 15 bonds have been issued, with total capacity of USD2.9 billion. Japanese earthquake is the most common of the perils covered by catastrophe bonds in the Asia Pacific region: eight have come to market in the past 11 years.

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*Securities or investments, as applicable, are offered in the United States through GC Securities which is a division of MMC Securities Corp., a US registered broker-dealer and member FINRA/SIPC.  Main Office:  1166 Avenue of the Americas, New York, NY 10036. Phone: (212) 345-5000. Advice on securities or investments in the European Union is provided through GC Securities Ltd., authorized and regulated in the U.K. by the Financial Services Authority.  Reinsurance products are placed through qualified affiliates of Guy Carpenter & Company, LLC.  MMC Securities Corp., GC Securities Ltd. and Guy Carpenter & Company, LLC are affiliates owned by Marsh & McLennan Companies.  This communication is not intended as an offer to sell or a solicitation of any offer to buy any security, financial instrument, reinsurance or insurance product.

By GC Securities, a division of MMC Securities Corp.*

The far-reaching effects of the ongoing global financial catastrophe have led investors and catastrophe bond sponsors to question the status quo. While the (re)insurance industry has persevered (particularly relative to the banking industry) it is evaluating the true extent of the risk that it has assumed. For sponsors of catastrophe bonds, this includes the reliability of the total return swap counterparty used to guarantee the collateral backing the risk transfer protection and the catastrophe bonds—as well as the quality of the collateral itself. While four catastrophe bond issuances have been affected by the bankruptcy of its swap provider, there are several areas on which sponsors and investors can focus to bolster the strength of their collateralization.

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Christopher Klein, Global Head of Business Intelligence
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The time-honored principle of diversification used in many areas of financial management applies equally well to reinsurance placements. From the ancient days of river commerce in China, where merchants divided their cargo between barges to avoid total loss, diversification has been a key principle of insurance and later reinsurance markets. Given the current financial turmoil in reinsurance markets, there is a legitimate pressure from investors, top management, and the rating agencies for cedents to seek only the highest rated of reinsuring partners. But this worthy objective needs to be balanced with the diversification principle, so that cedents can reduce their probability of zero recovery, as demonstrated in the above analysis.  

This series is limited to consideration of diversification among a panel of reinsurers. Cedents also have options to diversify to other forms of risk transfer, notably risk securitization. In particular, catastrophe bonds as currently structured may reduce the credit risk practically to zero, because they mandate a full collateralization of the limit at risk.

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Book Value Update: Earnings Announcement Impact: the erosion of balance sheets continues, as the effects of a global financial catastrophe spread across financial markets.

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Get Credit for Your ECM with S&P: Standard & Poor’s (S&P) has released a new framework for determining whether a carrier’s own ECM can receive partial credit in the S&P capital adequacy evaluation.

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Financial Catastrophes: No Storm, Plenty of Damage: throughout 2008, every major city in the world felt the reverberations of a “financial catastrophe,” triggered by the collapse of the subprime mortgage market.

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Uncover and Mitigate Product Liability Risk: Avert a Casuaty Catastrophe: Casualty Cat, a new model developed jointly by Guy Carpenter and Arium, Ltd., seeks to identify the hidden product liability accumulations in a carrier’s portfolio and delivers the insights needed for informed action.

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Defining the Value of Risk Management: the fundamental activity of risk-bearers has not been measurable, leaving a cloud of ambiguity in the middle of every carrier’s operation.

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Alternatives to Alternative Capital: (re)insurers have come to expect that alternative sources of capital will always be available, but the well may be at risk of running dry.

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As measured by the S&P 500 Insurance Index, carriers have lost 15 percent in weighted average book value since the beginning of the year. This represents a significant change from the 9 percent level at which the index stood for the past several weeks. European carrier results are in line with the global trend. The weighted average book value of the Dow Jones Euro Stoxx Insurance Index is also off approximately 15 percent this year.

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David Piebe, Chairman of Global Client Development
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(Re)insurers have come to expect that alternative sources of capital will always be available. Private equity funds, hedge funds, and other alternative investment vehicles have contributed copious capacity to risk-bearers since the turn of the millennium, and especially following the 2005 storm season. The well, however, may be at risk of running dry.

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David Priebe, Chairman of Global Client Development
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Earlier this year, the (re)insurance industry celebrated an abundance of capital. Buybacks and dividends were common, as carriers struggled to find productive uses for their extra cash. Only a few months later, we are in the midst of a financial catastrophe that is wreaking havoc on balance sheets and constraining carrier access to capital. And, the situation could worsen. A major catastrophe event could place substantial demands on (re)insurer capital in a climate where replenishment would be both time-consuming and costly.

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Nick Frankland, CEO of European Operations
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The (re)insurance market is fraught with uncertainty. As the next renewal looms large, buyers and sellers are attempting to find common ground for risk-transfer pricing, particularly in the wake of a high-frequency hurricane season and a severe financial catastrophe with implications for both sides of carrier balance sheets. While it is too early to tell if reinsurance rates are turning, it is clear that continued substantial declines are unlikely.

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Christopher Klein, Global Head of Business Intelligence
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The ongoing financial catastrophe is already shaping the market’s perception of the next reinsurance renewal. A unique confluence of factors has complicated the annual ritual of anticipating the direction of reinsurance rates. Though a number of factors have coalesced to prevent the continued rapid decline in risk-transfer pricing that characterized 2008, pricing on average at January 1, 2009 renewals is likely to remain within a narrow range of expiring rates. Nonetheless, the global credit crisis is far from over. Conditions are changing daily. New financial developments—or a mega-catastrophe—could change market conditions substantially and with little lead time.

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