Despite a run of softening years, pressure on casualty lines is yet to prompt a turn, with troubled economic conditions and higher insurer retentions likely to sustain a troubled period for casualty reinsurers.
Casualty reinsurance has had a difficult few years, with protracted softening characterising rate developments on the line. Apart from occasional upticks associated with events such as Deepwater Horizon and sectors such as life sciences, leading lines such as directors and officers (D&O) and workers’ compensation have continued to drift downward, with many in the sector arguing that casualty lines are bumping along the bottom. However, it is clear that in the current environment there remains little confidence that casualty rates will reverse any time soon.
Talking with David Kalainoff, chief underwriting officer, US reinsurance at Alterra, he conceded that there is every expectation within the sector that “rates will continue to erode”. About the only lines on which there are expected to be rate increases are in the “community bank space, where we have seen rate increases on the back of recent bank failures”, life sciences and on excess casualty business that was exposed to Deepwater Horizon “where we are seeing 150 to 200 percent rate increases on some of the higher layers”. He added that medical malpractice remained stable, but that otherwise the picture is troubled, with the sector “bumping along the bottom”.
Anthony Bonfa, senior vice president, excess casualty manager at Arch Insurance, painted a similar picture stating that “all the signs are that we will see a continuation of rate declines, and I don’t see a catalyst for change in the immediate future, unless something dramatic happens”.
Retention the leading concern
Turning to the causes of sustained softening on casualty reinsurance, Bonfa said that the current “plateauing is driven largely by underwriting restraint”. Primary insurers often not deploying their full capacity, he said, which is “creating a ceiling on rates”. He added that insurers are “retaining more premium than they had in the past and retaining more than is usual at this stage in the market”. The issue is that there “is not really impairment on the carrier side”, so there are few opportunities for increases, he said, with exceptions in life science and North American energy being driven by a “genuine lack of capacity”.
Kalainoff concurred, adding that insurers are “absolutely retaining more risk” with good profits and surpluses enabling them to retain more business. At the same time “reinsurance terms are not as favourable as some insurers might like, and as such they are buying less reinsurance”.
Bonfa was inclined to agree, indicating that there is less demand on the primary side for reinsurance. This is driven partly by the limited availability of reinsurance at favourable terms and partly by insurers retaining more of the business as an “easy way to create growth”, he said. Bonfa admitted that high insurer retention “could prove a real vehicle for capital depletion” if significant exposures emerged, adding that “if carriers under-price their business there will be a price to pay eventually”.
Levers of change
Despite the protracted soft cycle, levers of upward rate change are yet to coalesce. Examining them closely, it is evident that at least some of the levers can exert downward pressure as readily as they can upward. As Kalainoff outlined, the “economy and investment returns are perhaps the most crucial upward and downward pressures”, with the erosion of reserve redundancies also playing a role. Touching uponthe investment environment, he described the current environment as “quite challenging”. He said that in Alterra’s case “our reinvestment rate is currently around 2 percent and our aggregate overall portfolio is a little over 3 percent, so returns are quite poor”. Similarly, reserve redundancies were creating additional upward pressure, Kalainoff asking whether the casualty sector is “at the bottom of the tank”. He said that reserves “have probably run out from the mid-2000s”, with the development likely to place upward pressure on rates. However, he was clear that further downward pressure could be applied by improving investment returns and a further dip in the US economy, which would act as a dampener on demand for casualty re/insurance as payroll is reduced.
"Further downward pressure on rates could be applied by improving investment returns and a further dip in the US economy."
Bonfa said that the major pressure on casualty reinsurance rates remains availability, and with “the universe of available reinsurance having shrunk considerably” it seems likely that insurers will look to retain more of their casualty business, creating further pressure on the line. However, potentially dangerous accumulations exposed by events such as Deepwater Horizon and declining reserve releases might yet act as an upward driver. As Bonfa outlined, “the signal to a turn is going to be that carriers are increasing reserves rather than releasing them. We still see people releasing from older years, but new years seem to be increasingly under-reserved and as the pendulum swings the other way, that is when we will be primed for changes to take place”.
Addressing specific drivers, Kalainoff said that Deepwater Horizon had proved an “eye-opener regarding the aggregate exposure that you can get from a single systemic event, and one that hit a significant number of policies”, with rate increases on North American energy indicative of these increased concerns. Another potential gamechanger for the US casualty landscape could be the outcome of the tussle over Transatlantic’s hand. Transatlantic’s eventual suitor might opt to reduce the firm’s sizeable portfolio of casualty business, which Kalainoff agreed could create opportunities considering “the amount of business they write in the space”.
Little solace in cat losses
Considering the extent of property catastrophe losses over the last 18 months, their effect—if any—has been decidedly limited on the casualty side. Rather, as Bonfa made clear, “I suspect that there will be a disconnect between the two as long as reinsurers are well capitalised. However, as the situation deteriorates and they are obliged to stretch their capital a little further, then a real dislocation in the property market could create a much bigger opportunity cost for them to write casualty. As it stands, I agree there is a disconnect, but as this market grinds on, there is more potential for capital erosion from property or a real market opportunity on property, that will pull capital away from the casualty side”. It would seem that rather than acting as a potential upward driver on casualty rates, events on the property cat side might yet sap further interest and availability from casualty lines.
Kalainoff similarly commented that “moderate to high property cat losses appear not to impact the casualty space”, but added that if there is “enough erosion of capital to prompt firms to withdraw capacity, that might affect casualty rates”. Pressure from property cat, it would seem, looks set to be limited. Good news on the casualty front remains light on the ground.
Casualty, re/insurance, Alterra, Arch, D&O