The reinsurance market is like a crème brulée, says Michael Faulkner. How hard is the crust?

Is the reinsurance market like a crème brulée? In its recent report on the reinsurance market, the Benfield Group says that expectations of a prolonged hard market are looking "unrealistic" and that the market could be seen as "hard on top, but soft underneath" - just like the French dessert.

Good news then for insurers, who have been breaking their teeth on the brittle surface over the past year. In fact some insurers, like AXA, were even "pleasantly surprised" by a few of their renewal terms. Perhaps reinsurance is starting to look a far more appetising dish.

But as any seasoned diner will tell you, one restaurant's crème brulée may be very different to another's: for, while some have a thin dusting of sugar, others have far harder crusts.

In some reinsurance market sectors, a glut of capacity has emerged and rates are showing signs of weakening; in others capacity is still at a premium and the hard crust still looks very thick indeed.

Uneven distribution

The reinsurance market is facing an inadequate and uneven distribution of capital. The influx of new capital into the industry following the events of 11 September has not been sufficient to compensate for the massive outflows caused by falling stock markets, reserve strengthening and catastrophe losses. And this capital is congregating in certain sectors such as property catastrophe and fleeing from others such as liability.

Mark Hewett, deputy chairman of Guy Carpenter, Marsh's reinsurance broking arm, says: "Primary insurers may say that they are paying a lot for their reinsurance. But lots of capital has been destroyed - it is a global business. There is a declining number of reinsurers, and they have global interests and more balance sheet exposure."

One sector where the sugary crust appears to be pretty thick is the motor reinsurance market; the current round of renewals demonstrating that insurers stand little chance of making it to the soft stuff.

Motor insurers have found their reinsurance premiums have moved up dramatically, driven by increasing claims costs and the poor performance of some primary accounts.

Highway Insurance managing director Andrew Gibson says that reinsurance for excess of loss cover has gone up by as much as 20%, although the precise figure for Highway's account has yet to be finalised.

And policyholders will inevitably bear the brunt of these increases.

"We have two choices: to carry the increases and erode our profitability, or pass them on to policyholder," says Gibson. "We will be looking to increase rates. The question is whether can we achieve this."

But what increases can be expected? Gibson says that a 20% increase in reinsurance premiums would probably be translated into a 1%-1.5% increase in primary rates, although the figure would depend on the precise nature of an individual insurer's reinsurance arrangement.

"If the insurer simply increases its retention [and buys less reinsurance] then this will not increase reinsurance costs. But in the long run claims costs will increase which could affect premiums."

Gibson also points out that last year primary rates increased by 1%-2%, which he puts down to a hardening reinsurance market.

AXA reinsurance manager Mike Roberts says that the pricing impact on AXA's policies will be "negligible". But Roberts says that one of the most significant changes in 2003 will be the introduction of third party property damage limits for private motor policies.

"With effect from 1 July, reinsurers will limit this to probably £20m per vehicle. But we have yet to determine the limits in underlying policies and they could be lower."

Withdraw

Other insurers are still negotiating the level and timing of this limitation.

A further change that is being proposed by reinsurers, says Roberts, is the withdrawal of unlimited bodily injury cover in motor policies. But if this were to happen then it would need primary legislative change for insurers to be able pass the limitation on to policyholders, as they have a legal obligation to provide unlimited cover.

In any event, "there is no sign that reinsurers would try to act ahead of legislation," says Roberts.

The casualty market is harder still. Hewett comments: "This has been the most difficult area. Spiralling losses have driven away capacity from classes such as professional indemnity, directors' and officers' (D&O), and employers' liability (EL). UK EL, for instance, has seen increases of between 20% and 50%."

D&O has posed the most problems, according to Benfield Group's market review. "Most reinsurers have either decided not to write the class or only support the existing cedants," says the review. "There has been a substantial reduction over the past two years in the number of London markets which write D&O. Unlike capacity in other classes this has not been replaced by new entrants or existing players filling the gap."

And these pricing and capacity issues will inevitably filter through to policyholders. "Given that primary capacity is also diminishing, it's going to be a double whammy on businesses," says Hewett.

Limit Syndicate 386 active underwriter David Constable, for instance, says that primary insurance rates for EL will be increased by a minimum of 30% in 2003 depending on the trade.

Asbestos exclusion

Brokers and their clients will have to continue to grit their teeth in 2003.

Cover has also been an issue. Groupama reinsurance manager Kelvin Phillips says: "Reinsurers have clearly indicated their concerns about the potential for asbestos-related losses and the nature of the required exclusions continues to be negotiated."

And Roberts confirms that AXA's reinsurers have imposed asbestos exclusions on public liability business since 1 January this year, although there has been no change to EL.

"We will have to pass on some form of limitation to our policyholders, but this has not yet been finalised. It will be decided over the next month," he says.

Roberts also says that the issue of toxic mould has been discussed with insurers, but so far there have been no exclusions other than on professional indemnity business.

But when will the softening that the Benfield Group predicts occur in the liability market? Benfield Group head of research Julianne Jessup admits that she "cannot say", and Roberts says that "it is too difficult to predict given the uncertainties surrounding terms". Constable at least offers the figure of a minimum of two years.

So 2003's reinsurance market is not going to provide any relief to business struggling with their liability premiums.