After a period of soft-market conditions and lax underwriting capped by the Sept. 11 disaster and the Enron fallout, reinsurers are finally beginning to see the market turn in their favor.
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After its worst year ever, the property/casualty reinsurance industry is in correction mode, and, barring any major catastrophes, it seems poised to enter a period of profitability.
In 2001, the World Trade Center attack followed by the failure of energy trader Enron Corp. took its toll on property and liability, primary coverage and reinsurance. The costliest U.S. catastrophe ever came as property/casualty reinsurers were trying to recover from the slippage in the marketplace in the late 1990s, when reinsurers in a soft market were chasing market share, prices were dropping, and terms were very generous.
Lines such as workers' compensation carve-out, workers' comp catastrophe, excess commercial risk and aviation have been hard hit since the terrorist attacks. Insured property losses from the terrorism attacks are estimated at $20.3 billion, reports the Insurance Services Office Inc. The loss estimate represents only property damage and related coverages, such as business-interruption insurance, and it doesn't include liability insurance, workers' comp and aviation losses and life and health insurance, ISO said.
Since Sept. 11, fresh capital has been flowing into the insurance industry in response to tight capacity and rising premiums--two ongoing trends that were intensified by the terrorist attacks on the World Trade Center and the Pentagon. And new companies have been formed in certain market segments--a development that may reflect a drive to benefit from hardening market conditions or an affirmation of long-term confidence in the insurance business.
Reinsurers are "raising prices, tightening terms and conditions, segregating terrorism from core coverage--it's hard to see how it can get any better than that," said William Heckles, chief reinsurance officer of Hartford Steam Boiler Group Inc., a specialty reinsurer. "Reinsurers have found some confidence--they know that they're in the driver's seat at the moment. And when it comes to price and terms, they're more than likely to get what they want, so the pendulum has swung in the other direction."
Indeed, by June the Reinsurance Association of America had confirmed what the trade press had been reporting for some time--that reinsurers are returning to tougher underwriting. The 30 U.S. reinsurers that participated in the association's first-quarter survey wrote an increase of 15% in net premiums--to $7.68 billion from the $6.68 billion they wrote in the same quarter a year earlier, based on statutory results.
Also, these reinsurers, which represent about 75% of U.S. reinsurance premiums, posted a drop in their total combined ratio to 101.8 from 106.4 for the same quarter in 2001. Combined ratio is the ratio of claims and expenses to premiums earned.
While this group still paid out nearly $1.02 in claims and expenses for every $1 in premium received, it was a vast improvement over year-end 2001, when reinsurers spent $1.42 in claims and expenses for every $1 in premium received.
Joseph B. Sieverling, vice president and director of financial services at RAA, called this a sign of premium increases and the hardening market. The industry, he added, was moving toward underwriting profitability. With investment income not as robust as it had been because of the turbulent equity market, insurers could no longer rely on investment income to make up for unprofitable underwriting, he explained.
In recent months, members of the National Association of Independent Insurers, the property/casualty trade association that represents more than 690 carriers, report that they have been subject to "much more individualized underwriting by reinsurers. They are looking at the risks they are underwriting with more scrutiny," said Mike Koziol, senior director and counsel for the NAII.
Koziol said that while Sept. 11 and the already-hardening market have caused some distortions, reinsurers are responding with market-based solutions.
"The reinsurance marketplace is working--under some strained conditions--but it is working as a free market," Koziol said.
Terrorism coverage is a good example, he noted. While many reinsurers now have excluded this, others have not and are covering terrorism to a limited degree based on the nature of the underlying risk, Koziol said. Bermuda start-up Montpelier Holdings Ltd., for example, is writing a limited amount of terrorism coverage, with dollar limits per loss and a limited amount available in the aggregate.
As before, cedants still like dealing with reinsurers that demonstrate specialized knowledge and financial strength and those they know and trust, said Peter Porrino, global director of Ernst & Young's Insurance Practice. But some ceding companies may have capital issues, because their premium growth is accelerating--something that makes rating agencies nervous--and there is concern about under-reserving in terms of asbestos and other reserves, he said.
"These trends are causing a number of ceding companies to access the reinsurance market and obtain a reasonable level of capacity," Porrino said. "That's really helped some of the bigger players in the reinsurance market, because they do have capacity."
Since Sept. 11, reinsurers have developed a renewed focus on geographic concentration of noncatastrophe potential loss risk, Porrino said. They also are weighing credit-risk aggregation, which is more driven by the Enron scandal than the terrorist attacks, he noted. The Enron collapse produced a wave of aggregating exposures, potentially targeting insurers for liability losses through directors-and-officers, errors-and-omissions, fiduciary liability, and surety insurance policies, as well as an insurer's own investments.
"People are looking at how their risks are aggregating across credit exposures," he said. "And they are looking at industry exposures more than they had in the past. The whole crisis with Enron and the other energy companies brought that to fruition."
To Porrino, the biggest change lately in the reinsurance market has been the cost of capital, with reinsurance companies beginning to seek returns on their capital more in a capital-markets sense than they had before. Rate increases in the primary market and the reinsurance market occurred not only because of the additional risk or the need to replenish profits, but also because of a more conscious effort to obtain "a decent return on the cost of capital," Porrino said.
"With contracts that had very limited risk, companies were still looking to get a minimum return on their capital," he said. "So deals that were priced very thinly because there was little risk, changed pretty dramatically right away."
Following the terrorist attacks, the industry clearly demonstrated a drive for profitability over growth, Porrino said. But this tendency had been building earlier as a result of reserving problems with asbestos, as well as the poor performance of the capital markets. "All of those things seemed to come together and drive the prices to where they are going today," Porrino said.
Buyers may not like current market conditions, but at least the business is more organized now than it was in the chaotic weeks following the World Trade Center collapse, Heckles pointed out. Cedents have to feel more comfortable if they understand at least where the reinsurers are coming from these days, he said. "It was so difficult to get their attention on the phone" immediately after Sept. 11, Heckles said. "I don't think they knew what they wanted to do in the late fall."
Before long, the reinsurance market saw a dramatic development: the obvious transfer of importance from London to Bermuda as at least nine start-ups surfaced in Bermuda to fill the capacity shortfall. The new companies, which include Axis Specialty, formed by Marsh & McLennan's private-equity subsidiary, MMC Capital, and DaVinci Reinsurance, started by Renaissance Re Holdings Ltd., have more than $10 billion in capital.
"Let's make no mistake--the new Bermuda start-ups are backed by smart money and have smart people running those businesses, so you don't expect them to do a number of silly things," Porrino said. "At the same time, I do think there will be some pressure to produce revenues commensurate with the amount of capital that they have."
All in all, the capital shortage envisioned for the reinsurance industry wasn't as extreme as expected, he said. That is partly a result of capital flowing readily back into the marketplace.
In May, for example, Wellington Underwriting plc, a major managing agency at Lloyd's, said it had raised 448 million pounds (about $659 million) of capital to launch a new reinsurance company outside of Lloyd's that will be one of the largest stand-alone reinsurers in the London market.
Wellington Re was expected to begin operations by the end of June, said Candover Investments plc, one of the new venture's backers. It will focus on property/casualty reinsurance and U.K. commercial insurance, taking advantage of rising rates and a favorable underwriting environment, Candover said. The reinsurer expects to write net premiums of about 200 million pounds in 2002.
Wellington also announced that U.S.-based Berkshire Hathaway Inc. would invest to increase Wellington's managed underwriting capacity at Lloyd's to œ963 million from 625 million pounds. The plan was approved by capital providers on Wellington's syndicate 2020 and by Lloyd's.
The top five global reinsurers by gross premiums written, according to A.M. Best Co.'s 2000 rankings, were Munich Re, Swiss Re, GE Global Insurance Holdings, Berkshire Hathaway and Hannover Re.
But Robert Hammesfahr, a member of law firm Cozen O'Connor, thinks that Sept. 11 is already having a big impact on market share.
"It will be interesting to compare the market position of each reinsurer pre-World Trade Center and post-World Trade Center plus one year," he said. "Already, we have seen some reinsurance companies withdraw from the marketplace."
In February, for example, Bermuda-based Overseas Partners said it would sell its U.S. operations and put most of the rest of the company into runoff. The move means that Renaissance Re has lost a partner that provided it with $400 million of capital to write additional business. Now Renaissance Re will have to write business at a lower level of capital in the near term, according to a Morgan Stanley report released Feb. 13. Overseas Partners was originally created as a captive for the United Parcel Service in 1983.
Porrino thinks that on an accident-year basis, the prospects look good for reinsurers in 2002 and even better in 2003.
But the calendar year is more problematic, he noted, with the asbestos deterioration as well as fairly significant under-reserving as a result of inadequate pricing in the late '90s. "I don't think you're going to see many mid-teen [returns on equity] in the insurance industry in 2002, but you're more likely to see that in 2003," Porrino said. Rates will continue to rise--perhaps not at the pace they've gone up over the past 12 to 18 months, but they won't be flattening out right away, he said.
Heckles said he thinks reinsurers will maintain their newfound upper hand for some time because of the major contraction in the market in quality and security. "There are companies out there that have problems--they're just not quite out in the open yet," he said. "I think probably some companies are going to have to pull back and reduce the size of the lines they put out."
Considering the amount of change this market has seen over a short period of time, there's bound to be more shake-out through the rest of 2002, Heckles said. "And when we come around to the [Jan. 1, 2003] renewals, I don't anticipate the market will yet be back to normal--whatever normal is."
by Barbara Bowers
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