Rate cuts look good for insurers on the surface, but do they pose underlying risks?

In its report on the 1 January 2011 renewals, reinsurance broker Willis Re pointed out that the current trading environment – in which reinsurers are making diminishing underwriting returns because of falling rates – can pose challenges for buyers even though they are getting cheaper reinsurance. The broker argued that any shocks, stemming from either underwriting losses or other capital events, could push rates up sharply.

Given the deleterious effect they have on their trusted business partners, and the volatile condition they create, are cheaper reinsurance rates a false economy for buyers? Aon Benfield chief strategy officer Bryon Ehrhart argues not.

“For reinsurance buyers this was a very successful renewal period all over the world, even in catastrophe-affected areas,” he says. “In places such as Chile and New Zealand, where you have had events, the effect on consumers and businesses has been very limited. A lot of that has to do with the value of reinsurance. Most of that loss can be transferred into the international reinsurance market, where there has been a very small amount of price change related to those actual events.”

From strength to strength

While acknowledging that falling rates are reducing reinsurers' expected underwriting returns, Ehrhart believes reinsurers are stronger than ever, and show little sign of weakening. According to Aon Benfield, the reinsurers it works with are likely to report combined capital of $465bn for the full year of 2010, down slightly from the $470bn they had at the nine-month stage.

“From a trusted partner perspective, the partners our clients are trading with have the highest capital levels they have ever had,” he said. “Even though reinsurers are doing large share buy-backs, they are generally ending the year with more capital than they started with.”

One of the issues highlighted in the Willis Re report was the pricing differential between insurers and reinsurers, which, despite predictions to the contrary, it believed had not narrowed. “As a result, primary carriers are purchasing less, particularly in casualty lines, and reinsurers are seeing reducing premium volumes,” Willis Re chief executive Peter Hearn wrote in the report.

According to Ehrhart, the 1 January 2011 renewals have at least partially redressed the balance. “We have made progress towards closing the gap on existing transactions,” he says. “The reinsurance price decreases have reflected those in the primary market, and then ceding commissions and other terms were eased to provide another 5%-10% reduction.”

As a result, reinsurance rates are at least keeping pace with, and in some cases falling faster than, the underlying insurance prices. “This means that the partnership between insurers and reinsurers has been renewed. They are in sync,” says Ehrhart.

Retaining the risk

However, business lost through differing opinions about price has yet to be regained. Several years ago, reinsurers and their customers disagreed about the potential loss ratios of certain casualty business – reinsurers expected loss experience to be worse than insurers did. As a result, insurers opted to retain the risk, rather than buy reinsurance. Over time, the business has performed better than even the insurers had estimated, so they are keen to hang on to it.

Erhardt is hopeful progress will also be made here. “It was a failing of the reinsurance market to serve the insurers. That is recognised and we as brokers are working with reinsurers to address that.”

While the recent renewal season may be a net positive for reinsurance buyers, it could disappoint those who welcome choice. Ehrhart believes the prospect of dwindling returns could prompt more merger activity in the reinsurance industry. “I believe there is room for two to five more significant reinsurer mergers in 2011 and 2012,” he says. “The numbers will make that conclusion clearer, because the expected returns have again reduced. If you take 5%-10% off the top line, that tends to have a more dramatic effect on the bottom line.”