Posted on 31 Jul 2009
The predicted hard market has not materialized as for European reinsurers, as unique economic conditions combined to keep pricing constrained in an otherwise favorable market, according to a report by Bernstein Research.
"The hard market has not come about," said Jonathan Hekster, an equity analyst at Bernstein Research and one of the authors of the report. "The price increases we've seen this year have been decent, but they don't make the hard market that was being predicted last year."
According to the Bernstein report, a clear picture of the renewals market is starting to emerge, and not only has the hard market predicted by reinsurers failed to materialize, but 2010 might see the market start to soften again.
The report said June 1 renewals, which were mostly dedicated to Florida natural catastrophe coverage at the start of the hurricane season, saw rate increases of 15%, less than expected due to an increase in fresh capital in the form of new sidecars along with "lukewarm" demand from Florida insurers.
July 1 renewals saw a 10% to 15% rise in what Bernstein describes as "capital intensive products driven by model retooling," but only marginal improvements in other areas.
According to the report, the January renewal season showed small to moderate price increases overall at about 2% to 3%. U.S. peak risks showed "decent" increases, but price movements were low to negative -- lower than the market might have hoped for last year.
Hekster told BestWire he believes the overall fundamentals of the market point to further softening beyond 2009. According to his report, one of the arguments in the past for hardening was the fact the fact that when levels of capital are depressed, demand for reinsurance needs to increase to relieve pressure on capital adequacy levels while supply should retract. In 2008, there was a certain amount of capital erosion as a result of the financial crisis.
But this time, according to Bernstein, the argument does not hold as assets, not liabilities, have lost value. As a result, although capital has been reduced it has not been lost forever as asset values can recover. The report claims that for reinsurers, the solvency level is "broadly consistent" with 2005, suggesting that although capital has been reduced it is still at a reasonable level.
Although historically reinsurers have never achieved their targets of around 15% return on equity across the cycle, instead getting closer to 8% to 10%, in 2006 and 2007 they performed far better than average, at 15% and 11%, respectively. According to Bernstein, this means that rate increases in 2010 on the grounds of low profitability cannot be justified.
"From 2007 to 2008 balance sheets got hurt substantially, with a 20% loss of assets," Hekster said. "I think that people focused too much on that matter. Yes, we were down by about that number, but that was from a very lofty level. It was not like it was in the 1990s, when it was a very soft market. Surpluses were built up." Hekster said the reinsurance market was able to build up a cushion, which absorbed the losses from 2008.
Also, demand for reinsurance does not seem to be increasing for two main reasons. The first is that primary insurers are retaining more risk structurally. "There's a fundamental trend that primary insurers and reinsurers are not going to be as avid users of reinsurance as they have been," said Hekster. "They're getting more clever about what they're doing."
The second reason is that there has been a short-term drop in demand caused by the recession, as for example construction companies do not need as much insurance because they're building fewer structures.
The Bernstein report points out that with 95% of market volume now renewed, it expects prices to come down again in 2010. But very large losses, along the lines of a $100 billion natural catastrophe, could change this situation, said Hekster.