STOPPING the Freight Train

A $25-billion loss would stop the global reinsurance market’s downward pricing trend, but an $82-billion loss would be required to turn the market, according to a panel of experts appearing on an A.M. Best Webinar.

In State of the Global Reinsurance Market: Where the Hot Spots Are and Who’s in Them?, a panel of global reinsurance experts said the reinsurance market has the will to stop the downward pricing trend, but not the means.

Stephen Hitchcock, managing director at Lockton Re, said the current market has too much capital chasing too much premium. “It’s a market that wants to harden, but can’t — in the same way the insurance market wants to charge more, but the direct buyer has just squeezed a tighter margin, so [the buyers] would prefer to drop cover rather than pay an increased price,” Hitchcock said. “The same is true, I think, of the ceding company. So, the will to harden is there, but the flesh is weak.”

So far, 2010 has been a “tough one” for reinsurers, Hitchcock observed, with plenty of medium-sized cats producing a large number of losses. “I think the market has bruised knees, but we haven’t had enough blood yet to really see a hardening.”

What would it take to shift the market? According to Brian Ingle, executive vice president at Willis Re, if a “Hurricane Andrew-type event” hit the Florida coast, causing $25 billion in insured losses, “we think that would stop the downward trend, but it wouldn’t turn [the soft market hard].”

Bryon Ehrhart, Aon Benfield’s chairman of analytics and investment banking, said the next major event would have to hit both insurers and reinsurers. He noted a 115% combined ratio [COR] for the insurance industry was required in each of the three most recent market turns.

“To make [2009’s] 101% [COR] a 115%, it would take an $82-billion hurricane, which is a 1-in-150 year event,” Ehrhart said. “It would take a $72-billion earthquake, which is roughly a 1-in-250 year event. We do feel some of the ingredients are there, but it’s going to take a significant event to drive it. There’s not going to be enough momentum from declining returns to turn the market.”

Christopher Klein, Guy Carpenter’s director of reinsurance market management, suggested that, rather than focusing on the dollar sum, re/insurers should think instead of a shock or surprise event that would affect the market. He pointed to 9/11 and Hurricane Katrina as examples. Both were large losses; more importantly, both exposed deficiencies in the ways in which underwriters understood the accumulation of risks they had had on their books. “I still recall talking to Bermuda reinsurers shortly after Katrina and they were scratching their heads, trying to work out how they managed to lose a quarter of their surplus,” Klein said.

Hitchcock agreed. He added that recently the industry has experienced a high frequency of small-and medium-sized events in areas with high take-up of insurance and reinsurance. “If this [frequency of] activity carries on, that will change [the market],” he predicted.

MERGERS AND ACQUISITIONS

The abundance of excess capital in the marketplace may spur a flurry of merger and acquisition activity, the Webinar panelists suggested.

Ehrhart noted the industry returns for reinsurers average 11.4%. He said the industry works with volatility to earnings-per- share that amounts to roughly four times that of the Standard & Poor’s 100.

“It’s a volatile business,” he said. “Seeing the returns nearly get down to the cost of capital is fairly unacceptable to most investors. You will see boards and senior management come to the conclusion that single-digit returns are not acceptable for the kind of volatility that the market presents, so you will see more mergers. I do think that the credible balance sheet size is around $3.5 billion in order to participate in the casualty business. You’re going to find combinations that get people to that critical level.”

Ingle, on the other hand, suggested size is not necessarily going to be the driving force toward mergers. He predicted companies would be more likely to merge based on whether or not the two organizations complemented each other strategically.

“Of course size is important,” Ingle said. “You need that bulk, mass and ballast to compete in this market. But we expect there will only be mergers between complementary organizations. As a result, we don’t really see that many potential deals out there in which one company has a need and another organization fulfills it. So, we’re not expecting too much merger and acquisition activity in the near future.”

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With plenty of medium-sized catastrophes this year… the market has bruised knees, but we haven’t had enough blood yet to really see a hardening.