2012 renewals: coming up for air
Setting the scene
In 2011, $107 billion of insured losses were recorded, according to figures from Impact Forecasting, making the year the second highest insured loss year on record, surpassed only by 2005 and its cluster of hurricanes: Katrina, Rita and Wilma. Losses were two and a half times those of 2010, which was by all accounts hardly a glowing year for the industry, with 17 billion-dollar events marking 2011. Catastrophe losses ran the full gamut of geographies—Christchurch, Tohoku, the US Midwest, the US East Coast, Texas and Thailand— and there seemed no end to a list of loss events that just kept getting longer as the year progressed.
Figure 1 provides an indication of those geographies hit by major losses and how they measure up to average losses between 2004 and 2010. Few could argue 2011 wasn’t a tough year, and losses weren’t only diversified by geography. As Figure 2 shows, a mix of diverse catastrophe types punctuated 2011, earthquake losses from Tohoku and Christchurch chief among them. Meanwhile the final cost of some of the events—Thailand late in the year being perhaps the most obvious—are still to be fully calculated, so final loss estimates may yet rise. As Brian Boornazian, chief executive officer at Aspen Re put it: “The January 1, 2012, renewal season was preceded by a rather remarkable 2011.”
Adding further pressure to the underwriting position of reinsurers in January were the effects of RMS’s version 11 released earlier in the year, which prompted a sharp rise in probable maximum loss (PML) estimates for US windstorms and suggested similar upticks for European windstorms, although full model results are yet to be fully digested. Model changes led to rate increases in the US at the mid-year renewals and there was an expectation that further rate rises would need to follow at January 1 to reflect increased exposures, as model changes continued to place a strain on industry capital.
Meanwhile the investment environment in 2011 was hardly glowing, and continues to present challenges. According to statistics from Aon Benfield Analytics, 2011 net income for the Aon Benfield Aggregate group of reinsurers was 2.86 percent for the first nine months of the year, down from 9.1 percent during the same period in 2010. Investment gains also fell in the same period, from 5.34 percent in 2010 to a paltry 0.51 percent in 2011.
It seemed not even the investment side of the balance sheet could alleviate reinsurers’ woes. As Guy Carpenter detailed in its January 2012 Renewal Report, “carriers can no longer rely on investment income or reserve releases to compensate for underwriting weakness. As a result, accident year underwriting is now crucial to achieving profitability”.
The combination of significant cat losses and a troubled investment environment led to a decline in reinsurer capital in 2011, although one that was perhaps less marked than some had expected. According to figures from Aon Benfield Analytics, industry capital declined 4 percent to $450 billion by the third quarter of 2011. Losses were evidently an earnings events for the sector, but considering the level of industry capitalisation, 2011 losses appear to have been a rather more muted capital event for the sector.
"If they cannot achieve the rate they need to achieve in one particular market, they will have little choice but to try and compensate for this elsewhere."
As Guy Carpenter indicated in the renewals report, “dedicated reinsurance sector capital finished 2011 near the same level where it began. Improvements in enterprise risk management and effective capital management contributed to the success and strength of the industry”. Nevertheless, combined ratios rose worryingly during the year from 96.2 percent for the first three quarters of 2010 to 110.5 percent during the same period in 2011. This prompted calls for a return to technical pricing—even if some players insisted that they had always maintained such an approach—and a push for rate rises to reflect increased risk exposures and capital erosion.
Finally, there were concerns over the euro crisis, the wider economic situation and the implementation of Solvency II, factors all serving to heap further pressure on the reinsurance sector. The question was, had enough punishment been meted out to prompt a wider turn, or would 2011 losses, RMS 11 and anaemic investment returns bring about only localised rate spikes as many in the broking community had predicted?
Remarkable yes, but remarkable enough?
With the dust having settled after the flurry of activity that punctuated the start of the year, it would seem that a significant turn in pricing has once more evaded the industry, although upward rate developments have finally materialised. As Jamie Veghte, chief executive of XL Group’s reinsurance operations indicated: “the market is on a good plane right now. Rather than a jolting hard market brought on by a mega loss or massive balance sheet damage”, January renewals resulted in disciplined rate development.
Charles Dupplin, chief executive officer at Hiscox, Bermuda, said that January’s moderate rate rises were in line with industry expectations, adding that this year’s renewals proved “very satisfactory”. Marty Becker, chief executive of Alterra, spoke in a similar vein, saying that “there were no major disruptions during the renewals, with businessconducted in a timely manner”. Veghte concurred, arguing that “broadly we are looking at an industry that has had a very poor return profile for several years and has been exhausted by its situation. As such, I expect to see a slowly improving market going forward”.
Cat-hit geographies experienced the most marked rate increases— some of which were significant—with US and international pricing recording appreciable rate rises following a string of cat events. Becker said that for property cat “international exposures in the Asia Pacific region showed the greatest price increases and probably the greatest stress because that was where all the losses were”, but 2011 cat losses had a decidedly international flavour. However, many of the regions that experienced losses—particularly in Asia—are yet to renew and in some instances are still counting the cost of insured losses. The situation skews the renewals picture somewhat, with additional rate rises expected later in the year. As Becker indicated, “at the big international renewals on April 1 and July 1, we expect there will be some stress on the line”, and further prospects for rate rises following significant cat losses.
However, not everyone was enamoured with the outcome of this year’s January renewals. Boornazian said that “in some lines of business—in property catastrophe business linked to lossaffected contracts, for example—rate levels have begun to get closer to where we would like to see them”. However, he argued that casualty business remains underpriced, with the industry experiencing only flat to modest rate increases in January “which is clearly disappointing”, while rates in non-cat affected territories could benefit from a further uptick.
Tom McKevitt, executive vice president, Bermuda and international reinsurance at Allied World, spoke in a similar vein, arguing that while January renewals resulted in some upward rate movement they nevertheless fell short of expectations. He said that US and international renewals had proved generally satisfactory—driven as they were by cat losses and RMS 11—but indicated that European property cat and US casualty rates had been rather disappointing. McKevitt said that the industry had hoped for more positive upward development, although he indicated that January is likely to be the starting point for further upward rate movement as the industry heads deeper into 2012.
As Boornazian outlined, “if you consider the range of hard market drivers that now exist, with all these factors at work it seems improbable that a protracted soft cycle can continue. Yet still, in many areas, the cycle is taking a long time to turn, and far longer than ideally it should”. Perhaps the final insured losses from the Thai floods and a dramatic denouement in the euro crisis might just prove enough. Further cat losses would also help. But after $107 billion of insured losses in 2011, what could prompt a wider turn?
For Boornazian “it is difficult to give an absolute figure, because numbers like these are relative”, but following 2011 events “the size ofloss now needed to trigger a turn would probably be less than in 2010”. Addressing the details, Boornazian said that “a single loss event, such as a large US hurricane, would probably have more impact on rates than three or four smaller events around the world”. Occupying the first two ‘pillars of reinsurance’—US wind and US earthquake—it would appear that a significant US loss or losses still holds the key to a marked rise in reinsurance rates. Losses in other geographies remain only local drivers.
However, as the industry becomes increasingly globalised and “companies take exposures not only in their home market but around the world ... companies will need to charge adequately for all of their exposures. If they cannot achieve the rate they need to achieve in one particular market, they will have little choice but to try and compensate for this elsewhere”, Boornazian said. McKevitt said that indications of this knock-on effect were evident on US lines in January, where wider property cat rates benefited from recent cat losses, although he argued that RMS 11 changes remains the most significant driver for unaffected lines. Similarly, on international property cat there has been some ‘contagion’ on upward rate developments, but as McKevitt argued, having been underpriced for some time price increases weren’t entirely unexpected in response to 2011 losses. Turning to casualty lines, however, he argued that movements in property cat are unlikely to translate into the sector— there simply remains too much disconnect.
Globalisation and the significance of recent international exposures were a theme of Guy Carpenter’s report, Catastrophes, cold spots and capital. “Exposures previously considered ‘cold spots’ caught many insurers by surprise in 2011. As international insurance penetration and wealth grow, carriers must focus on emerging ‘peak’ risks in areas which would not have been considered risky in the past,” it reported. Australia, Chile, Japan, New Zealand and Thailand all fall into this category of socalled cold spots—regions that have broadsided the re/insurance industry in recent months. With increasingly global books of business and a high degree of interconnectivity by both geography and line, such a trend should encourage greater correlation in global pricing with a suggestion that this was already in evidence at this year’s January renewals.
An uptick, but some had hoped for more
Despite upward development, particularly in cat-hit international geographies and the US, a number of factors continue to hold back significant rate hikes. First among them seems to be reinsurer capital. Despite claims from reinsurers to the contrary, brokers continue to argue that the industry remains well capitalised and that there needs to be an adjustment within the industry to a new norm: a generally soft market with localised spikes. But as Boornazian made clear, such talk “suggests that you became comfortable with a ‘new normal’. I’m not convinced that the market has ‘adjusted’, rather it is under quite some pressure”.
He said that not only has the industry suffered some $107 billion in cat losses, it has also had to factor in “reserve releases drying up” and the implications of RMS 11 “which has already led some players to reduce the amount of catastrophe business they are writing”. Add in investment and regulatory pressures and the new norm is beginning to look decidedly uncomfortable. Boornazian agreed that “rate changes will always spike in some areas more than others, but the industry as a whole needs to achieve improved rates for the exposures it carries”.
Meanwhile, despite suggestions that RMS version 11 would prompt significant price increases in North America, non-uniform adoption of the model changes has meant upward rate development has been subdued. US catastrophe losses from Hurricane Irene, tornado outbreaks in Birmingham and Joplin and wildfires in Texas appear to have been far more significant in generating rate increases. According to Aon Benfield Analytics: “The significant changes in frequency estimates for severe US hurricanes were muted by reinsurers (and insurers too) researching and adopting their own considered frequency opinions.” Questions raised over the veracity of RMS’s loss cost analysis and less severe loss estimates from AIR Worldwide and Eqecat have helped to lessen the impact of the RMS model changes. However, Boornazian added that the full impact of RMS version 11 was yet to play out and that its assumptions had already “led some players to reduce the amount of catastrophe business they are writing”—suggesting this might place upward pressure on the line.
The state of the insurance industry also continues to play into the dynamic, placing downward pressure on reinsurance pricing. According to details published by Aon Benfield in its January Reinsurance Market Outlook, insurers remain relatively well capitalised, with the sector continuing to retain premium despite conditions. The report also said that capacity was being held back by primary insurers as they waited for the market and its pricing environment to settle. Aon Benfield Analytics said that insurers are experiencing an improved pricing environment, but little in the way of growth, suggesting that additional premium is unlikely to be transferred into the reinsurance arena.
Reinsurers, for their part, were rather more bullish about the insurer-reinsurer dynamic, particularly in Europe. They recognise that insurers aren’t immune from the pressure exerted by near-record insured losses, RMS 11 and anaemic investment returns. Factor in capital adequacy requirements under Solvency II and exposure to the eurozone crisis—both of which are considerable concerns for insurers in Europe—and reinsurers can be confident that ceded premiums will remain buoyant heading into 2012.
Line by line
US property cat
US property cat reinsurance rates renewed up 5 to 15 percent in January, according to statistics from Guy Carpenter, with recent cat activity and RMS model changes the most prominent drivers. Rate increases broke a cycle of declines that had been in train since 2005, driven by around $100 billion of US cat losses and revised RMS wind science. On property per risk insurance, there were “modest rate increases” and more significant rises on loss-affected lines, but smaller, regional business remained flat. Aspen said that the flat rate situation was “driven by a small number of markets offering their capacity at low rates”. Turning to catastrophe facultative reinsurance in the US, Boornazian said that “demand is up as buyers adapt to RMS Version 11. The result has been “noticeable hardening on lower-attaching, catastrophe-exposed business, and a general stabilising”.
European property cat
European pricing has been competitive for some time and there had been some expectation that price hikes would materialise in January. However, due to light cat losses during 2011 and adequate capacity, rate increases were decidedly muted. As Boornazian outlined, conditions resulted in a “largely flat market with rate improvements held back by excess capacity to only single-digit percentage increases”. McKevitt concurred, but added that RMS 11’s European models were yet to be fully digested by the industry. Going forward he said that the RMS model changes in Europe may aid future rate increases but it depends on if/how reinsurers adopt and adjust the new model. Whether increases will be as marked, may well depend on cat losses in 2012. Meanwhile, the crisis in the eurozone and the demands of Solvency II might also help change matters, although the rate environment in Europe remains doggedly firm.
International property cat
International coverage experienced by far the most dramatic rate increases, with some cat-hit lines achieving four figure percentage increases. The Asia Pacific was particularly affected, Boornazian indicating that “major losses in Australia, New Zealand, Japan and Thailand have resulted in cat excess of loss ratios for the reinsurance market of more than 1000 percent”. However, as McKevitt outlined, with the rate on the line in international geographies having been so low in recent years, even significant upticks were only bringing pricing into more sensible territory. Significant rate increases were evidently needed to reflect losses across the Asia Pacific and it seems that the industry was generally happy with those rate rises achieved at January 1. With many programmes set to renew later in the year— Japan, for example, has its universal renewal date at April 1—there is an expectation that further rate upticks—some of which will are likely to be dramatic—will follow in 2012.
Casualty
One of those lines that appears to have disappointed is casualty. McKevitt said that the pricing environment has been so bad in recent years that Allied World has opted to walk away from underpriced casualty business rather than “chase it to the bottom”, with January bringing little in the way of cheer. While there are some “positive signs on the horizon” according to Boornazian, including an increasing willingness among reinsurers to walk away from underpriced business, a reduction in reserve releases, low inflation and a poor economic climate, January renewals “lacked the increases necessary for long-term health”. He said that some primary carriers had seen low single-digit increases on their renewals, but for reinsurance rates remained “generally stable”. For US casualty business there were pockets of upward rate development and a limited number of requests for decreases, but generally the line remained stubbornly stable.
For international casualty reinsurance, the picture was of no improvements in “rates or terms due to significant insurance and reinsurance capacity fighting for regional European business”. In general Boornazian argued that “casualty rates are no longer as attractive as they once were, and need to turn upwards in order to properly reflect the underlying exposures, along with compensating for the current low investment yields in the underlying reserves”.
Specialty lines
Specialty lines experienced something of a mixed picture at January 1. “Specialty business can present strong market opportunities but the current renewal was mixed. We have seen meaningful rate increases on offshore energy treaties affected by 2011 loss activity, but in other areas rates remained flat or decreased,” Boornazian said. Addressing specific changes on the lines, he said that “marine business that has not experienced losses is commonly being renewed at flat rates, or is even seeing low single-digit reductions.While for terrorism, programs that saw losses from the recent civil unrest in Thailand realised some rate increases at renewal, while the remainder of the market has seen general rate reductions.”
Finally, a turn?
After a difficult few years for reinsurers, punctuated by significant rate declines and a softening market, “we are finally seeing evidence of a market turn”, said Boornazian. McKevitt likewise predicted that reinsurers can expect further rate increases moving forward, with upward rate developments in 2012 likely to reflect 2011 cat losses and the ongoing digestion of RMS 11 in Europe and the US. And it seems that even Guy Carpenter concurs, describing conditions as a “transitioning market” in its review of the renewals season. However, Boornazian argues that “real change is still needed in many areas ... some renewals in January were sensible and reflected appropriate lessons learned. However, others have been very disappointing”. January renewals certainly served to establish a new heading for reinsurance. Further upticks—outside cat-hit territories—would be an added welcome development.
