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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By David Priebe, Chairman of Global Client Development
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The climate change debate is likely to continue unabated well into the future. Even if it is not settled anytime soon, the debate itself has already begun to affect the (re)insurance industry. Risk-bearers deal in probability routinely, making climate change another likelihood to consider. In this manner, it has entered natural peril models, risk management assumptions, and risk transfer strategies. Consequently, climate change has become part of the (re)insurance lexicon, despite the fact that scientific, sociological, economic, and political authorities have not reached a universally accepted conclusion. The absence of a definitive answer does not preclude the use of climate change-related information in risk portfolio management.

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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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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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By David Priebe, Chairman, Global Client Development
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The capital models for (re)insurance risks are evolving. Over the past 15 years, alternative sources of capital have become increasingly important, particularly in the capital-constrained environments that follow major catastrophe events. As expected, capital market vehicles such as catastrophe bonds and sidecars have brought additional capacity to risk-bearers when they need it most, alleviating price pressure as a result.*

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Capital Markets Provide Necessary Depth

David Rains, Managing Director
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Life carriers struggle with the notion of hedging pandemic risk. The probability of an event occurring in any particular year is low. Even if an outbreak does occur, the process for estimating losses and determining reserves is unclear. Capital approaches do not consider probabilistic tail scenario risks. Quite simply, managing pandemic risk is an effort mired in doubt, though the potential for a devastating, multibillion dollar, worldwide outbreak is real. Traditional risk transfer tools have only limited utility in covering pandemic exposure. However, the depth and flexibility of capital markets may provide a robust alternative to traditional reinsurance.

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The amount coming into the market has increased after each mega-catastrophe. This probably reflects the increased knowledge of insurance markets by the investment community, the increased liquidity and depth of capital markets overall, and the growing size of the losses and concomitant opportunity.

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For placement where the expected LOL is less than 1 percent, capital market solutions are most attractive, as most reinsurers will charge minimum ROLs while capital markets can diversify. LOLs between 1 percent and 7 percent suggest convergence. The diagram shows a number of instances where catastrophe bonds are priced below traditional reinsurance. For LOLs higher than 7 percent, traditional markets dominate, due to the higher underwriting sophistication and knowledge required.

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