January 2010: a long way down
It seems that the industry’s negative forecasts for January renewals have once again been proven correct, with brokers reporting continuing softening across almost all lines. There had been hope—if little expectation—that the new year would usher in a turn in the market, but those conditions that characterised the soft market of 2010 have largely remained in place. Excess capital remains stubbornly high up the list of downward pressures on rates on the line, but a relatively benign hurricane season in 2010, issues in the wider macro-economic environment and favourable casualty reserve developments have all helped to sustain the soft market into another year. The situation has meant that reinsurers continue to struggle to allocate capital to risks that will result in favourable returns, prompting further rate declines virtually across the board.
Addressing rates on the line, the brokers appear to be in agreement regarding the level of general softening, with Aon Benfield, Guy Carpenter and Willis all recording declines in the 5 to 10 percent range. Caveats were made by all three brokers regarding the mobility of specific lines, such as marine energy and South American earthquake, but it appears that in general the softening has followed the same trajectory it established at the last renewals. The industry continues to face what Guy Carpenter’s Global Reinsurance Outlook terms a “climate of persistent low valuations”, with the broker predicting “no clear catalyst [for change] on the horizon”. Putting a timescale on the prospects for a turn, James Geffen, head of reinsurance at Miller, made clear that he couldn’t “see anything happening for 18 months”, predicting a continued “slow drift” in rates going forward. About the only positive news to emerge from renewals was that “reinsurers lowered rates at a pace less marked than the decreases in January 2010 renewals”, according to Aon Benfield’s Reinsurance Market Outlook, although as Geffen made clear, while “the decreases have slowed...that’s not the same as saying that there is a proper correction in the marketplace”. And despite suggestions that a host of pressures might bring about an upturn in rates, all of the brokers seemed to point to further softening in 2011.
Line by line
Addressing those lines that have seen the greatest movement, it seems that those impacted by major catastrophe events such as Deepwater Horizon and the Chilean and New Zealand earthquakes were about the only lines to see any upward movement at these January renewals.
According to results from Willis’s 1st View report, offshore energy recorded “large primary rate increases” and “large increases in XL rates even on loss-free programs”—with the impact of Deepwater Horizon and what Willis described as “tight” capacity helping to drive rates upwards. Again, such movement appears to be following rate trends established earlier in the year, although the Sudden Oil Spill Consortium of Munich Re, Willis Re, Aon Benfield and Guy Carpenter, developed in 2010 in response to the Deepwater Horizon disaster, may begin to help to steady rates for offshore energy as much-needed capacity is brought into the market.
About the only other major movers have been rates for Chilean cat coverage—with the February quake still resulting in “sustained rate on line increases of 40 percent to 60 percent, depending on specific loss experiences”, according to Guy Carpenter—and New Zealand and Australian coverage, which was hit by an unusually severe cat season in 2010. Three loss events each totalling more than $1 billion in insured damages have helped generate rate increases on loss-free lines of 3 to 5 percent, while those lines directly impacted by the Christchurch earthquake and the two Australian hailstorms saw increases between 10 and 15 percent, according to Guy Carpenter. Nevertheless, the impact of specific loss events has largely been limited to those lines directly affected by cat events, with Aon Benfield making clear when addressing the situation in New Zealand that pricing “is very much loss experience driven and pressure on retentions remains isolated”.
In terms of downward movement on the line, it seems that continued negative pressure is being exerted across almost all other lines, with the most significant movement being seen in US agriculture, which fell 10 to 15 percent at the January renewals; workers’ compensation, which was flat to down 12 percent; and US property catastrophe, which fell by between 8 and 10 percent, according to statistics from Guy Carpenter. Aon Benfield and Willis painted similar pictures of rate declines, with few lines escaping the general softening that has been a characteristic of the ratings environment over the last 12 months. Only those lines that experienced direct loss activity saw any rate increases and even these were geographically isolated or industry-specific, with little impact beyond their immediate line and location.
Too many Benjamins
Addressing the major downward pressures on rates, overcapitalisation continues to top the reinsurers’ list of pressures, with Guy Carpenter describing excess capital as the “primary driver of lower rates”. According to the broker’s Global Reinsurance Outlook, the industry is overcapitalised to the tune of $19 billion “in excess of historical levels given risks currently assumed”—or 11 percent of total dedicated capital. Examining the capital situation more closely, Aon Benfield’s renewals report indicated that the industry’s level of capitalisation has been on the rise since 2008, with total reinsurer capital reaching a little over $450 billion in 2010. This is against a backdrop of falling returns on equity, which spiked in 2009 to 15 percent, but fell markedly in 2010 to around 10 percent, said Aon Benfield. The situation has encouraged reinsurers to pursue business more aggressively, further exacerbating the downward spiral of pricing. Addressing the level of demand for reinsurance, Aon Benfield’s report found that while demand rose by 2 percent in 2010, reinsurer capital rose by 17 percent in the same period. Such developments in the make-up of supply and demand are unlikely to alleviate further downward pressure.
There may have been some hope that declining investment returns would prompt a turn, but softening rates have continued despite a tough investment environment. Peter Hearn, chief executive officer at Willis Re, indicated that the broker could see “no discernible impact on pricing from greatly reduced investment returns”. It seems that the industry is yet to lose enough capital, even as investment income remains sluggish in the face of wider macro-economic pressures. Meanwhile, M&A activity, which “picked up dramatically in 2010 from the very low levels of 2008 and 2009”, according to Aon Benfield, has likewise failed to change the landscape. A number of Bermuda players were included in those acquisitions that punctuated 2010—Canopius, Flagstone Re and Max Capital all acted as acquirers in 2010—but it seems that despite suggestions that such moves might act as a brake to further softening, M&A activity has evidently not been as significant or widespread—in terms of scope and impact—as some in the industry would have hoped. Hearn indicated that “the number of completed deals remains modest due to significant execution hurdles”. Low valuations, which Guy Carpenter indicated are currently languishing at 0.91 of price to book value, and uncertainty regarding the best means to put capital to work, are unlikely to change circumstances significantly in 2011.
Prompts for the turn
Addressing what might bring about a hardening of rates, it seems that a host of factors have the potential to do so, although none have yet gained sufficient traction in the current industry environment. There are however indications that conditions are approaching a turn, with Guy Carpenter indicating that there are “an increasing number of latent factors which—alone or in combination—could at some point precipitate a meaningful change in the market’s direction”. Topping the list of possible catalysts is a market-changing cat event—something in the $50 billion-plus range—which would help remove significant capital from the market. However, Guy Carpenter’s report indicated that a cat event in the order of $150 billion in magnitude would be required to “create a sustained and long-term market turn”, with a lesser event unlikely to prompt more than localised and temporary hardening.
Further pressure may well be exerted by “negative underwriting cash flow”, according to Guy Carpenter, with figures from the broker indicating that underwriting in the key US property and casualty sector has fallen into loss territory, following a downward trajectory that has been virtually unbroken since 2003. And although the broker admitted that such pressure alone would in all likelihood be insufficient to turn the market, it could well act as a further brake on softening. Aon Benfield, for its part, pointed to declining levels of net written premiums (NWP) in the US as a possible indicator that the market is set to harden. According to figures from Aon Benfield, NWP as a percentage of US gross domestic product (GDP) fell to 2.89 percent in 2010, the lowest level since 1970. The broker indicated that historically a turn in the market has occurred whenever NWP as a percentage of US GDP has fallen below 3 percent, and so there may be some expectation that underwriting pressures will lend further weight to a possible upward turn in the market.
Finally, share buy-backs and a predicted decline in reserve releases might also generate some momentum for an uptick in the cycle, but it seems that only a host of factors, and not one in isolation, will bring an end to the present soft market. Fortunately, pressures are beginning to stack up, and although there appears to be little change in the immediate downward trajectory, in the medium term, a shift does seem inevitable. In the meantime however, it appears as though the fierce competition for ceded premiums will remain a feature of the market, meaning that the coming year is unlikely to be an easy one. As Willis’s chief executive officer, Peter Hearn, made clear, the “global reinsurance industry faces tough prospects for 2011”.