Lara Mowery, Managing Director and Head of Global Property Specialty
Property-catastrophe reinsurance rates increased by 15 percent at the Florida-centric June 1, 2009 renewal — compared to a 15 percent decline a year ago. Capacity was more limited than in recent years — however, still adequate to complete renewals. Though the ultimate result was higher than the 10 percent to 14 percent change for U.S. national reinsurers at April 1, 2009, the intricacies of the Florida market render it directionally consistent with the overall rate trend for this year. Constraints on capital have pushed risk-transfer pricing higher, but shortages were not so severe that rates spiked as they did in 2006.
Rate Increases Lower than Expected
Reinsurance rates increased approximately 15 percent on average for Florida property-catastrophe insurers, below the 20 percent that many anticipated. Capital was constrained both as a result of the ongoing financial crisis and a modest increase in demand for private reinsurance of approximately 5 percent to 10 percent. This increased demand stemmed from the USD2 billion decline in the Florida Hurricane Catastrophe Fund‘s (FHCF’s) Temporary Increase in Coverage Limits (TICL) layer and efforts by insurers to address liquidity needs within the remaining TICL layer. The FHCF’s retention adjustment upward also led to some increased demand for coverage below the FHCF in a year where many companies did not see surplus growth to support a larger net position. There was enough capacity in the market to meet cedents’ needs, but absent a buffer, prices were pushed higher.
Firm order terms (FOTs) were up 10 percent to 14 percent year-over-year for lower layers and 14 percent to 18 percent for higher layers. The quoting process was much tighter than in earlier renewals this year — with an average range of -3 percent to 3 percent around the average quote. Though there were some outliers, cedents and markets generally understood the factors affecting capital availability and risk-transfer pricing, narrowing the disparities seen in January and April.
FOTs were 95 percent of average quotes for both lower and higher layers at the June 1, 2009 renewal. The average FOT was 86 percent of the maximum quote and 108 percent of the minimum.
The June 1, 2009 renewal experienced a shift back to the equivalent of 2007 pricing on a risk-adjusted basis. Lower layer FOTs increased an average of 11 percent this year, compared to an 11 percent decline last year and a 15 percent drop the year before. For middle layers, FOTs gained 14 percent this year, compared to downward changes of 15 percent and 17 percent in the last two years, and higher layers were up 18 percent — a stark change from the -19 percent last year and -23 percent the year before.
Nonetheless, this year’s rate increases remained far below those of June 1, 2006, which had price jumps of 22 percent, 29 percent, and 45 percent for lower, middle, and higher layers, respectively. This year, even higher layers did not pierce the 20 percent threshold, on average, and remained at least 50 percent below the increases that followed Hurricanes Katrina, Rita, and Wilma.
Historically, Florida domestic companies have needed available capacity of USD20 billion to USD25 billion. More than half comes from Bermuda, with 18 percent from the United Kingdom, 10 percent from hedge funds, and 19 percent from other capital sources. This year, traditional capacity fell approximately 10 percent, and hedge fund-supplied capacity dropped by approximately a third. There was less capital than usual in the marketplace, causing many to worry that supply would not meet demand.
Though there was sufficient capacity in the market to meet cedents’ needs this year, the days of “excess capital” are clearly behind us.
Insurers faced a delicate situation at the June 1, 2009 renewal, having to balance retained exposure and net premium carefully. Wind mitigation credits and reinsurance costs were the primary drivers behind a 20 percent fall in retained premium. As a result of these factors — and coupled with the prevailing investment environment — many Florida insurers posted net losses last year while seeing net exposure increase because of a reduction in FHCF coverage and an increase in the FHCF retention.
Of course, the global financial catastrophe impacted the Florida renewal, as well. As measured by the Guy Carpenter Global Reinsurance Composite, reinsurers lost a considerable amount of capital last year, with shareholders’ equity falling 18 percent. Isolated efforts to raise fresh capital resulted in a reported shareholders’ equity increase of 4.6 percent, showing some signs of promise in a difficult environment. Adjusting for the reclassification and revaluation of securities and reserve releases, though, the effective increase was only 1.4 percent.
Because reinsurers raised little capital between the January 1, 2009 and April 1, 2009 renewals, the rate increases at the beginning of the year continued three months later. The unique constraints on the Florida market make this year’s 15 percent reinsurance rate increase consistent with the U.S. market’s 10 percent to 14 percent increase (for national programs) two months ago.
Capital constraints were not unexpected at the June 1, 2009 renewal; cedents were merely unsure of the degree. The resulting 15 percent reinsurance rate increase suggests that capacity conditions have not worsened through 2009 and that the market has stabilized to some degree. Confidence has certainly increased as a result of a recent recovery in financial markets and there is some evidence that equity and credit are becoming somewhat easier to secure. Adding to the Florida renewal season’s stability in the last few weeks were the improving conditions and the increased volume in the tax-exempt municipal bond market leading to an increase in the FHCF’s post-event bonding capacity estimate to USD8 billion from USD3 billion in October 2008. Conditions likely have not turned, but the precipitous declines appear to have ended.
A Leading Indicator for 7/1
Developments in Florida have worldwide significance every year, and the impact was heightened for the most recent reinsurance renewal. The capital constraints discussed since November 2008 indeed led to increased rates, but the severity was lower than anticipated — as it was at January 1, 2009 and April 1, 2009. The extent of the impact has been relatively consistent, as well. The chain of renewal events, therefore, is likely to extend through the imminent July 1, 2009 renewal, as the effects of global phenomena are leading to only slight variations locally for property-catastrophe insurers.
Even though insurer and reinsurer first quarter financial results are still being reported, a view of the second quarter is beginning to coalesce. Efforts to raise capital continue, albeit slowly and with results consistent with the Global Reinsurance Composite’s first quarter adjusted shareholders’ equity growth of 1.4 percent. The underlying capital condition is unlikely to change by July 1, 2009, unless a mega-catastrophe strikes or a resurgence of the capital market mayhem from the fourth quarter of last year occurs.
For the near term, 2009 will likely progress as it has so far: manageable rate increases driven by limited but available capacity should be the norm. Local results for July 1, 2009 — like the recent Florida renewal — are likely to involve modest adjustments on the prevailing global cost of transferring risk. Early market entry remains the most effective way to manage price and secure coverage.