The reinsurance industry is flying high, so why do the analysts remain so gloomy?

In February, there seemed to be an endless procession of reinsurers unveiling stellar profits for 2009, not to mention excellent takings in the January renewals. Several companies actually posted the best sales figures in their history: Montpelier Re, Axis Capital, Allied World, Endurance, Catlin and Platinum Underwriters all announced record results either for the year or the last quarter. Meanwhile, Hannover Re announced its second-best annual results and Munich Re returned record dividends to shareholders.

So what is the reason for such a buoyant market, and will it continue? For starters, most reinsurers have said an unusually benign cat season enabled them to take pristine balance sheets into 2010. But that alone does not make for such healthy figures; there have been several years in the past two decades when low cat figures did not correlate with high returns.

The reality is that benign loss figures and low attritional losses were important adjuncts to a background of helpful factors, notably extreme caution in underwriting and pricing discipline on the back of the financial crisis. Economic uncertainty also served as a good reason to raise rates.

Then there was an unexpectedly rapid improvement in capital market conditions, including recoveries in equity market prices. Fitch points out that reductions in corporate bond spreads bolstered reinsurers’ capital positions significantly in 2009, which have now returned to near pre-crisis levels in 2007.

But it wasn’t all plain sailing, and 2009 called for unique manoeuvres by reinsurance bosses and underwriters. PartnerRe boss Patrick Thiele believes the art of reinsurance management is simply better now than it was 15 years ago, with a greater focus on cycle management and product diversification, while modelling, risk management and technical pricing have also advanced. There does appear to have been a common understanding that underwriters had to maintain discipline, as well as prepare for Solvency II and potentially leaner times in 2010.

Reading the tea leaves

With reinsurers’ capital at near-historic peak levels, it might come as a surprise to know that rating agencies in particular are not joining the celebrations. Fitch expects that the large release of reserves in 2008 and 2009 (on business done in 2002-2006) will not continue in 2010. This, coupled with a soft rate environment, “will reduce earnings in 2010” says a Fitch statement on Bermuda-based carriers.

Moody’s says the continued soft market will place additional pressure on reinsurers’ underwriting margins and profitability during 2010. Soft reinsurance pricing, it says, results from both increased capacity and reduced demand. “This soft market could also mean that the credit profile of the reinsurance industry may not be as healthy as current capital levels indicate. Additionally, in the absence of attractive opportunities on the underwriting side, reinsurers may step up share repurchase activity, which could increase their vulnerability to catastrophe losses.”

On the demand side, reduced economic activity and the strained reinsurance budgets of primary carriers have had an adverse impact on reinsurance purchases, says Moody’s. It voices concerns about excess capacity and slack demand. The rating agency, which has maintained a negative outlook on the reinsurance industry since September 2009, believes such indicators for 2010 could have negative implications for policyholders and creditors of reinsurers.

The final note of warning comes from Lloyds TSB Corporate Markets insurance relationship manager Seb Kafetz, who says investment returns are likely to be much lower, as reinsurers have moved out of equities and hedge funds into bonds and government-backed investments. “In addition, recession-related claims in political risk and specialty classes are likely to increase.”

Key points

  • Reinsurers have posted some of the best results for years, due to an unusually benign cat season and unexpected improvement in capital market conditions
  • Bosses and underwriters have had to perform some canny manouevres and maintain strict discipline on pricing
  • Rating agency Fitch is still pessimistic about the future, saying the soft market will put pressure on profitability
  • Moody’s voices concerns over excessive capacity and slack demand, and the effects this will have on policyholders and creditors