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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Sean Mooney, Chief Economist
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Despite the ambiguity pervading financial and reinsurance markets, it is clear that systemic risk has increased. Unprecedented chaos in financial markets left investors more risk-averse than they were at the end of the summer. They are demanding greater returns on the capital they put at risk. A closer look at the economic conditions underlying the marketplace, however, suggests that an increase of 1 percent to 3 percent is warranted for catastrophe covers, which should result in a minor impact at the January 1, 2009 renewal. Other factors, including the impact of the global recession on premiums and claims, the collapse in equity values, a rising distrust of modeled results arising out of Hurricane Ike, increased demand by cedents seeking to preserve their diminished capital, and diminished supply of reinsurance capacity, are likely to have a much greater impact on rates.

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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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Christopher Klein, Global Head of Business Intelligence
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In many instances, a common and useful approach to risk management issues involves establishing metrics and monitoring actions in light of certain benchmarks. Risk metrics are generally easier to understand and capture important summary information as opposed to trying to deal with, for example, a comparison of entire probability distributions.

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Christopher Klein, Global Head of Business Intelligence
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Case 1: Base Case

A hypothetical ceding company contracts for the USD200 million casualty cover from a single Aaa rated reinsurer. The probability of a default is 1 percent, with a loss of USD200 million, while the probability of no default is 99 percent and would carry no loss.

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Christopher Klein, Global Head of Business Intelligence
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Cedents are becoming increasingly concerned about the security of their reinsurers, particularly in light of the global financial catastrophe. Diversification, a time-honored approach to managing risk, may offer part of the solution. Cedents may benefit from diversifying reinsurance placements among many reinsurers. Thus, the approach applied to asset management can be applied to reinsurance placements, as well. The syndication process carried out within the broker market results in an important reduction of the “no recovery” potential that could arise from reinsurer defaults. Diversification may reduce the probability of no recovery, even if the likelihood of default among reinsurers is correlated.

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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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Christopher Klein, Global Head of Business Intelligence
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The popularity of sidecars seems to have ended. The availability of traditional capital and access to insurance-linked securities (ILS) and other alternatives simply has made sidecars less attractive. But, reinsurers know that the market can harden at any time, with one mega-catastrophe creating near-immediate demand for fresh capital. Low overhead and an inherent exit strategy are likely to help these vehicles regain prominence in the next hard market—with investors and reinsurers alike.

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Christopher Klein, Global Head of Business Intelligence
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The next renewal period may be four months away, but it is uppermost in everyone’s mind across the (re)insurance industry. Without a crystal ball, it is impossible to predict the market’s exact trajectory, but several trends have become evident in 2008. Absent a mega-catastrophe, rates likely will continue to trend downward but will be tempered by pressure on investment gains arising from the ongoing effects of the global credit crunch and reinsurers’ fears of an imminent market-changing disaster.

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Christopher Klein, Global Head of Business Intelligence
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Asset-driven losses have put pressure on earnings. Investment gains comprise an important part of carriers’ long-term profits, and financial markets have shown just how volatile this source can be. With net income off 60 percent from the first half of 2007 to the first half of 2008, carrier profitability will become increasingly reliant on technical earnings.

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