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Reinsurers Sees Strong Capacity A Key Factor for January Renewals

Source: A.M. Best

Posted on 29 Nov 2011

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Throughout the current reinsurance renewal negotiating season that began at Rendez-Vous in September and continued through Baden Baden, much discussion has centered on the market's resilient capacity in the face of big catastrophe losses, and whether that will be a factor in keeping pricing soft.

A.M. Best Co. said in its annual reinsurance market review, unveiled at Rendez-Vous, that "capacity has been dampened" this year, bringing on hopes of a harder market come January. Estimated catastrophe losses of as high as US$60 billion for the first half of 2011 "have diminished last January’s robust capital position," according to the report. "Companies are hoping for, but not betting on, a more dramatic improvement in property cat pricing at the January 2012 renewal."

The report added that "companies are managing capital to prepare for a potential hard market, but stopping short of committing to capital-raising initiatives. The stubbornly soft market and depressed valuations have chilled mergers, acquisitions and start-ups in recent years, but pressure to strengthen capital could lead to a thaw in such activity."

There doesn't yet appear to be a tightening trend in overall reinsurance capacity, but the conditions may be right in certain areas, according to Peter Roeder, the member of Munich Re's board of management with responsibility for global clients and North America.

"We do not yet see a general tightening of reinsurance capacity but there are developments, especially in long-tail lines of business, which have to be watched closely," he said. "For several years now, the industry has released reserves, with the first three quarters of 2011 continuing the pattern of releases at a strong rate."

Roeder said he could not comment on the reserve positions of other companies, but added in the past, the industry has taken down reserves by simply using up the "redundancy" to a point where "significant deficiencies" are created.

"If the economy in the developed markets remains weak, it will be difficult for companies to increase prices, putting greater pressure on cash flows and returns on equity, which may eventually force some companies into dangerous territory regarding reserve adequacy," said Roeder. "Those who rely on thin reserve cushions are potentially in a situation where they will no longer be able to sustain the level of capacity they currently offer to the market.

The general reserve situation of the industry, taken together with a continued low interest-rate environment, is bound to increase pricing discipline, especially in long- and medium-tail lines."

David Flandro, global head of business intelligence for reinsurance broker Guy Carpenter & Co., said despite the severe catastrophe losses of 2011, the year should finish "near where it began" in terms of capacity, a "remarkable" achievement. "We did notice that reinsurance capacity utilization rates increased at midyear renewals -- up to about 94% in June 2011 from 78% in the first quarter of 2010 -- and we expect this level of utilization to persist," he said.

Roeder said the reinsurance industry is estimated to have much lower excess capital now compared with year-end 2010, and this year's heavy loss burden has already had an effect on renewals to date. "We expect in part even more significant effects for the Jan. 1 renewals," he said.

Rate developments have not been uniform across the market, with the big catastrophes in the Asia-Pacific region and the United States affecting specific lines and markets, in addition to marine line developments. "Munich Re expects the trend to continue, as we are seeing a general firming in prices, not only due to losses but also supported by changes in catastrophe models used in the European and U.S. markets as well as the economic situation in important markets,' said Roeder.

Flandro added the reinsurance sector entered 2011 with 10% more capital than the historical norm given risks assumed. "This excess has been impacted by the catastrophes of 2011 but not yet exhausted," he said.

Even if pricing conditions improve and capacity remains adequate, reinsurers (and primary insurers alike) will be cautious about capital allocation, said Roeder. "The sovereign debt crisis in Europe and the USA, a sustained phase of low interest rates and heavy natural catastrophe burdens worldwide pose significant challenges for insurers and reinsurers," he said.

A strict focus on profitability in core reinsurance business "is more essential than ever," he said, a point Munich Re will emphasize as it goes into January renewals.

According to Flandro, Guy Carpenter has not yet seen "significant changes" in buying behavior due to changes in capital positions. Some primary insurers have large exposures to European peripheral sovereign debt, and many global insurers and reinsurers have had large catastrophe losses in 2011.

"Still, it is our experience that most carriers' solvency ratios and capital positions remain well in excess of required capital levels and most reinsurers maintain more than enough capital to operate as before," he said. "Capital growth has of course, been moderated by all of the events of this year, but in aggregate, capital positions remain sufficient both on the insurance and reinsurance sides."