After a troubled start, what's next for 2011?
2011 has had a troubled start. Flooding in Queensland, the Christchurch earthquake, the earthquake and tsunami in Tohoku, and more recently, tornadoes in the US have served to reawaken fears about the potential impact of major cat losses, with a fair amount of the pain making itself known on Bermuda’s shores. Loss estimates for the four events vary, but even a cursory examination of the figures provides some indication of their cost and potential implications. Recent estimates from Aon Benfield put this year’s Australian flood damage from Cyclone Yasi at $6.5 billion of insured losses; insured losses from the Christchurch earthquake at around $12 billion; and those from the Tohoku earthquake and tsunami at $30 billion, although they continue to develop; whilst the cost of recent US tornado damage has been estimated to be in excess of $4 billion by Aon Benfield. Totting up the figures, it is clear that a significant amount of global reinsurance losses have been—and continue to be—incurred across all four events, even if the impact of such significant losses has been muted by circumstance.
A key mitigant will be the share of the pain that local re/insurers and governments will shoulder in three of the four cat-hit geographies. Institutions such as the government-backed Japanese Earthquake Reinsurance Company and the Earthquake Commission in New Zealand will cover a significant amount of the costs in those geographies, while local insurers such as Australia’s Suncorp and Japan’s Mitsui Sumitomo Insurance will feel a large part of the remaining pain. Nevertheless, the extent of the damage has meant that a significant figure of losses have made their way into the global reinsurance arena, with Bermuda players hit by losses from all three—now four—cat-hit geographies. The events have meant that first quarter loss reserves have taken a battering, with a troubled start to 2011 creating evident concerns for the unhappy few caught by sizable, accumulated losses across all four events, particularly as the industry heads into what is traditionally a more active cat season in the second half of the year.
Ouch, that hurt...
Bermuda reinsurers have been busy of late assessing the damage wrought by a succession of major cat events, and after some initial fears—from those looking in—that events might lead to failures, it would seem that with the dust settling, the pain, while marked, will be borne out by the industry. Drilling into the specifics of the Bermuda market, a cursory examination of figures from the Aon Benfield Aggregate’s (ABA) analysis of reinsurance market cat losses provides some indication of the impact of events in Australia, Japan and New Zealand. Examining the ABA figures, it is evident that cat losses across the three events have eaten into between 2 percent and 21.4 percent of 2010 shareholder funds of those firms included in the aggregate, with results at the upper end of the scale evident cause for concern.
And judging the impact of losses against a second parameter—2011 cat losses as a percentage of first quarter net premiums earned during 2010—provides a further indication of the impact of 2011 events, with loss estimates accounting for between 16 percent and 139.9 percent of 2010 first quarter premiums. Although not alone in shouldering the punishment— with the likes of Munich Re, SCOR and Swiss Re also on the ABA list and recording significant losses from 2011 events—Bermuda players’ international footprint has meant that accumulative losses during the first quarter have been significant, prompting a closer inspection of pricing, exposures and the conditions for a possible turn in the protracted soft market.
Addressing the impact of first quarter events, Tom Hulst, chief executive officer of Ariel Re, made clear that events have had a “significant negative impact on expected industry results for 2011”. Analysis carried out by Ariel Re found that assuming “mean expected losses” for the remainder of the year, the “loss ratio for the international (i.e. non-US) property catastrophe market for 2011 will be in the range of 350 percent”. Such figures don’t bode well for those firms with significant international portfolios, with further analysis by Ariel Re finding that “if you combine this figure with an expected level of loss in the US property catastrophe business, the 2011 loss ratio for the property catastrophe reinsurance market in total will be in the order of 175 percent”. With Bermuda reinsurers accounting for a sizable amount of US and international property cat business globally, and with cat business making up a large percentage of their own books of business, such figures suggest that 2011 will be a troubled year for the Island’s reinsurance industry. As Hulst made clear, the eventual 2011 position of Bermuda reinsurers will be largely predicated on events impacting the balance of the year. Hulst predicted “an average year for the industry at best”, and should losses during the key US wind season prove to be significant, he said that it would be a “loss-producing year for many companies in Bermuda”.
Indicative of the impact of events has been the sharp rise of interest in retrocessional coverage. Cat losses have led to a busy period on retro lines, reflected in the hardening of retrocessional pricing and the level of interest in such vehicles as Alterra’s reloaded retro sidecar, New Point IV. Addressing rising interest in the retro market, James Kent, president of Willis Re, North America, indicated that Japan and New Zealand had been “relatively sizable retro events” with their impact serving to prove the “value of retrocessional cover”. And with most of the major cat risks yet to come in the balance of the year, it seems likely that increasing demand for retro coverage will be a characteristic of the coming months.
"With the US wind season just around the corner, it seems likely that further retro business will be done in the coming weeks as US cat-exposed reinsurers look to protect themselves from further worrying accumulations of losses."
Talking with Charles Cooper, president and chief underwriting officer at Bermuda-based XL Re Ltd, it is evident that much of this additional retro demand is coming from “US cat-exposed reinsurers... looking to protect themselves heading into US hurricane season”. With the US wind season just around the corner, it seems likely that further retro business will be done in the coming weeks as US catexposed reinsurers look to protect themselves from further worrying accumulations of losses. Regardless of which approach Bermuda reinsurers take, the purchase of further retro cover will have obvious implications for capacity and pricing, although the levels of capital sloshing around in the Bermuda market would suggest that retrocession and the destruction of loss reserves may yet prove insufficient to have any marked impact on the Bermuda market.
...but caused only a bruise
Despite the significant erosion of loss reserves, a major impediment to a possible turn in the market remains stubbornly in place: namely the high levels of capitalisation that continue to characterise the Bermuda reinsurance market. Brad Kading, president and executive director of the Association of Bermuda Insurers and Reinsurers (ABIR) put the capitalisation of ABIR members at the end of 2010 at $90 billion, a figure he described as “abundant” and enough to “handle cat losses”. And examining loss estimates for 2011 events at even their upper end, it seems that Kading is right.
Although cat events have resulted in a sharp rise in loss ratios, reinsurer capital remains stubbornly resilient, with any dollar erosion unlikely to significantly erode Bermuda’s sizable capital base. Figures from Aon Benfield Analytics found that global reinsurer capital grew by 17 percent in 2010 to around $470 billion, with ABA shareholder funds—of which Bermuda reinsurers account for a significant portion—rising by 18 percent or $38 billion during the same period. As Mike Van Slooten of Aon Benfield Analytics’ Market Analysis team made clear: “Capital was at an all-time high at the end of 2010. And after the noise of cat events, it is always worth bearing that in mind.”
Addressing the capital situation, Jamie Veghte, chief executive of XL Re Group’s reinsurance operations, reinforced the view that although events had been “quite significant”, they had broadly been “more of an earnings event than a capital destruction set of circumstances”. Veghte said that the industry’s “bloated balance sheet” had helped shield it from the impact of losses, and it would seem that despite the severity and accumulative nature of 2011 cat events, conditions are yet to coalesce into a turn.
Although bloated, levels of capitalisation are indicative of the strength of the industry. And it is this strength, according to Kent, that has muted the impact of events. As he pointed out, considered within the context of 2005 and hurricanes Katrina, Wilma and Rita, events over the past 12 months—Chile, the two New Zealand losses, Australia, Japan and now the US—were of a “similar dollar equivalent of insured losses” and yet their impact has been decidedly less significant. The reason for this, Kent said, is the capital strength of the reinsurance market. Comparing the 2005 market with that of 2011, he said “there is a huge difference”, with strong returns over the last four or five years, a “large amount of excess capital” and, most particularly, reinsurers being far less leveraged than they were six years ago. Kent agreed that “this loss [Japan] isn’t a one-size-fits-all” event, with its impact ranging from “small losses” for some reinsurers to a “capital event” for others. Nevertheless, Kading agreed that there is a “debate ongoing” regarding the impact that events will have on the current market cycle and whether they might build to a turn. What does seem apparent, however, is that reinsurer capital, whilst dented, will remain a cornerstone of the market as we head deeper into 2011.
Turn baby, turn
The question raised by 2011’s cat events has inevitably become: will the year’s troubled start lead to a market-turning event? It would seem, however, that there is no simple answer to the question and much will depend on how the US hurricane season plays out. Addressing the issue, answers are necessarily predicated by the caveat: what if? What if another Katrina-type event materialises, what if accumulative losses mount up and what if the appetite to keep pricing at current levels is unsustainable. Views remain mixed however, with a considerable divergence of opinion as to whether 2011 events—both those that have happened and those that may yet occur—will result in a turn.
Talking with Kent, he made clear that despite events during the first five months of the year, Willis Re “does not anticipate the marketchanging event that some people are referring to”. Kent said that for those territories “specifically hit by these losses...pricing will change”, with events prompting reinsurers to scrutinise more closely pricing on cat-hit lines and property cat lines generally, but he predicted no general hardening across the broader market. Kent indicated that following the levels of loss in such territories “risk adjusted price decreases are unlikely for property cat for the rest of the year”, but said that unlike in 2005, there would be no general jump in pricing and no market turn. Instead, he said any hardening would be limited in scope and geography to those lines impacted by events.
But not everyone is of Kent’s opinion, with Veghte stating that from XL’s perspective, the accumulation of losses have been significant, sufficient that “the extent of the loss in Japan is going to be the straw that broke the camel’s back”, at least on short-tail lines. Losses from Tohoku—now given further impetus by recent tornado losses in the US—were significant enough to be a “market-moving event for short-tail lines”, Veghte said. The ‘what if’ in Veghte’s insights remains the US hurricane season, with US mid-year wind renewals likely to act as a “bellwether” for pricing moving forward, but he said that those that “predicted high single-digit reductions” earlier in the year would likely be proven wrong. Veghte said that there has already been some repricing of rates on those renewals that took place on April 1, and moving forward, he predicted that “we are going to go from perhaps negative rate movement to at least level, if not up materially”. And recent US tornado losses are likely to strengthen such arguments. It would seem that there is an expectation—at least from certain quarters—that upward orlevelling rate movements on short-tail lines are on the cards. Much will of course be predicated by the remainder of the US hurricane season, but few would deny that a major event in the coming months would act as a significant driver for upward movement on cat lines, and for a possible wider turn.
Examining the implications of an event in the order of Katrina— i.e. $72 billion in insured losses according to estimates from Swiss Re—Kent agreed that such a cat event would be significant, particularly given the context of earlier 2011 losses. Whilst he doubted a smaller event would prove enough to turn the market, “a Katrina-type event would mean that just about every reinsurer that writes property cat reinsurance would produce negative earnings and lose additional capital—and at that point, the chances are the market would turn”. Kent reckoned that although not a certainty, its implications would likely be significant enough to “accelerate a change in pricing across a number of different lines”, not just catexposed lines. Much, it seems, will depend upon unforeseen events, and after the accumulative losses of this year, many reinsurers are looking again at their coverages and exposures, and considering carefully the implications of a major event—US hurricane or otherwise—in the coming months.
Duck and cover
The accumulative impact of events have prompted reinsurers to examine more closely their portfolios, encouraging some to reconsider their coverages and others the attractions of retrocession. Addressing the impact of 2011 events on reinsurer coverage, Kent said that “some reinsurers right now are looking at the very low rate on line layers that they write for international property catastrophe business and assessing whether that’s really where they want to deploy their capital”. Compared with rates on the line in the US, Kent said that certain international lines may prove unattractive, particularly considering circumstances in the first five months of this year. Such a realisation may well help to stabilise any hardening of pricing in the US, but has obvious implications for pricing on lines in non-core geographies, which can likely expect price increases at their next renewals. It would seem that the attractions of diversification—an aggressive hunt that characterised 2010—might well have been reduced by events, particularly in light of perceived inadequacies in cat models in non-core geographies such as Chile and New Zealand.
Veghte further indicated that one of the key lessons to have emerged from events in geographies such as Chile and Japan was that such markets are “overly reliant on proportional reinsurance structures”, with Veghte stating that it is XL’s ambition to “lead the way to more non-proportional structures with obviously stronger rate levels on the primary side of the business”. The accumulation of losses looks set to encourage greater caution among reinsurers and a re-examination of the possible loss implications of their exposures. Ducking of less attractively priced lines might just come to characterise 2011 international property cat business. The remainder of the year, it would seem, will be rather different from the same period in 2010.
Events have likewise encouraged a closer examination of the attractions of retrocessional cover, with both Japan and New Zealand proving to be “relatively sizable retro events”, in the words of Kent. Hulst agreed, stating that the accumulated losses across all four events will “increase interest in retrocessional coverage to limit downside for the remainder of the year”, particularly considering the extent of losses and that “most of the cat risk for the year is yet to come”. Hulst indicated that given loss activity and the resulting uptick in demand, the “pricing for retrocessional coverage will increase, making the decision between ceding and retaining risk more challenging”, but the level of losses will likely mean that reinsurers will look to cede at least some business into the retrocessional market. Striking the right balance of retained and retroceded business will be a significant challenge for the industry as we head into an uncertain US wind season.
Indicative of the rise in retrocession has been the level of interest in Alterra’s new retrocessional sidecar, New Point IV. Described as a “smart move for the long term” by Kent, it has been followed in recent weeks by a Validus sidecar, AlphaCat Re, and Lancashire’s sidecar, Accordion Re, and may yet encourage others, with Veghte indicating that should a busy US hurricane season materialise, XL might well consider a sidecar itself “if we thought the opportunity was there for us”. He noted that XL was the first reinsurer in Bermuda to form a sidecar in 2005 following Hurricane Katrina. Events, it would seem, have served to shake up both the retro market and what has— for a few years—been a relatively dormant sidecar market. Further retrocession, even after a busy past couple of months and hardening pricing, looks in the offing, particularly when one considers the battering loss reserves suffered in the first quarter. 2011 events are already suggesting a poor year for the reinsurance industry; it would seem that some players may well be considering reduced coverages and retrocession in order to guard against it being worse than that.
A troubled vintage
The US wind season will be watched even more closely than normal this year. Accumulative losses from a string of events, new, more costly cat models in the US and soft pricing across a host of lines all suggest that a major event might just build to a substantive turn. But even after a remarkably tough first five months, there still remains no certainty that events will result in anything more than localised, line-specific hardening. Instead, much will depend upon the loss potential of any further 2011 cat events, with the final reckoning, and its implications for the market, likely to be determined between June and November, and the key US hurricane season.
