So far, the year 2006 will go down in the reinsurance history books as the year of "Corporate Individualism." In the past, reinsurers suffered from "Pack Mentality" where it was all right to sustain losses as long as one's peers in the industry incurred the same level of losses. Neither the capital markets nor the rating agencies penalized companies so long as their results didn't materially deviate from the competition.
However with the unprecedented frequency of losses in 2004 and 2005 plus the size of the Hurricane Katrina loss which is now the most costly natural catastrophe on record, reinsurers whose results in 2005 differed widely from their peers soon found it extremely difficult to replenish capital and maintain adequate financial ratings to take advantage of the upswing in rates following the past two horrendous years.
Companies had to shed aggregate in the so-called "peak catastrophe" zones (Florida, Gulf Coast, New England, California) to satisfy more stringent rating agency requirements while concurrently attempting to make up the premium by writing more business in less catastrophe-prone regions. Such a strategic model became extremely difficult to fulfill and has resulted in a situation where there is not enough capacity for U.S. coastal hurricane and earthquake exposures, but more than enough and at very competitive pricing for non peak zone business, i.e. business in the Midwest, Asia, Southern Europe, Turkey, Mexico and Latin America.
The so-called "hard market" that many reinsurance experts had predicted after Hurricane Katrina materialized only for the peak zone catastrophe exposures. The rates for almost everything else, property and liability business, have come under enormous pressure as the reinsurance capital, old and new, seeks diversification away from the more volatile hurricane and earthquake business.
The question that needs to be addressed is whether there is enough of the non-peak catastrophe business to go around in order to establish the desired portfolio diversification and the returns the new wave of investors require? For the answer to this question, we will have to wait to see what the ultimate results look like for all of 2006 but so far, the results through the second quarter are looking great. For ceding companies, particularly the buyers of reinsurance, the change in the marketplace post Katrina poses a conundrum. On one hand, the regional insurance company that has no business in a hurricane or earthquake zone can count on a highly competitive market with an improvement in rates from a year ago. This was clearly evident at the July 1 renewals. However, for the large nationwide writers of business and in particular the regional writers in catastrophe-prone areas such as Florida, the buyers of reinsurance struggled with high retentions, high rates and in a number of cases not enough capacity to satisfy the program. Compounding the frustration of those buyers was a sense that reinsurers were quoting prices and terms to simply see how much they could truly get away with discounting underwriting information and model output.
A layer that last year cost 18% Rate on Line with a prepaid reinstatement was suddenly costing 35% Rate on Line with one reinstatement at 100%. While clients recognized that reinsurers indeed took it on the chin for the past two years, the new class of reinsurance carriers formed after Hurricane Katrina enjoyed a unique advantage. What is more evident today than ever before is that Excess-of-Loss reinsurance has evolved into a commodity. The movement away from proportional reinsurance to Excess-of-Loss reinsurance has drastically diminished the relationship between the reinsurer and the buyer. This is the primary reason why the new carriers entering the market in the post Katrina era have been so successful in attracting business.
All of this, however, could change overnight if another $40 billion loss occurs or a frequency of smaller size losses in the same season. Attracting new investment capital into the business to write simply property business is very difficult given the volatility of the product. Further, if consumers in catastrophe prone areas find it difficult to obtain insurance, either the states or the federal Government will have to step up to the plate which will be a very bad move for the reinsurance industry in general.
By Brian R. McGuire, Senior Vice President & Director, U.S. RE Corporation