Reinsurance Outlook

January 22, 2006

Although Katrina is long gone, the clouds of misfortune she and her sisters generated will linger for decades. They radiate well beyond Louisiana, Florida, Texas, Mississippi, Alabama and other regions into the heart of the reinsurance industry, which has been given one of the most serious wake up calls in its history.

“The storms of ’05 knocked the reinsurance marketplace into a cocked hat,” said Paul Walther, chief executive officer and principal consultant of Reinsurance Directions in Heathrow, Florida. “There’s a whole lot of scrambling going on, as they try and figure out how to cope with the losses.”

According to estimates by Insurance Services Office, the insured losses from the three hurricanes accounted for $45.2 billion, or 90 percent, of the total catastrophe losses of $53.5 billion from 22 events so far in 2005.

Furthermore, as the Property Casualty Insurers Association of American pointed out, these damage estimates do not include losses to utilities, agriculture, oil drilling platforms and property insured under the National Flood Insurance Program. The NFIP’s losses alone are now estimated at around $22 billion.

The loss estimates are largely based on overall industry estimates and could well increase as more actual claims are made and processed.

Effect on reinsurers and capital

“Multiple events were already a concern for the [reinsurance] industry after last year,” Walther said. “Now many players just can’t cope with the extent of the losses and the frequency with which they occur. They are wondering what to do.”

The first consequence in reinsurance will be delays-delays in renewing treaties, as reinsurance underwriters try to get some idea of their cedants exposures. There will probably be more delays on new treaties than on renewals, but both will be affected.

A quick tally of the losses of nine reinsurers comes out to nearly $15 billion. Taking just the Q3 loss figures cited for Bermuda’s reinsurers adds nearly $5 billion. That’s close to $20 billion that won’t be available to provide capacity. It has to be replaced, or the amount of coverage written has to be reduced to account for it.

Some companies, such as Munich Re, have already tightened up underwriting standards, mainly by refusing to renew marginal risks. They’ll continue to do so. Others may choose, or be forced, to follow the same strategy.

There is, however, the flip side. The reinsurance industry anticipates substantial premium increases, especially in property, commercial and other lines heavily hit by the hurricanes.

But each player has to position itself to take advantage of rising rates and may face some barriers, such as legacies or long term liabilities. While most reinsurers are raising additional capital, Walther stressed that the “magnitude of the losses, and the fact that the actual losses are still unknown, as well as the possible ‘spiral effect’ (when a reinsurer gets its own reinsured loss back),” make it harder to determine the amount of any capital increase and its cost.

Failure of cat models

With the computer age, it became possible to construct increasingly sophisticated models of what might happen in a number of given situations. Big Kat and her sisters have raised serious questions about the use of these models.

“Modeled loss estimates are only as accurate as the exposure data input into the catastrophe model,” stated Karen Clark, president and CEO of AIR. It turns out that data wasn’t very good. According to AIR, “the quality and completeness of most insurers’ commercial policy data is insufficient for a detailed and accurate assessment of their catastrophe risk.”

According to the models, Katrina should have been around a $10 billion event, Walther noted, but it cost three or four times that much.

“The numbers just aren’t credible,” Walther said, “so it’s back to the drawing board. The models were inaccurate; they were flawed, and you can’t rely on them.” The failure of the cat models increases pressure on reinsurers to find more accurate methods, including models, to adequately assess future potential losses.

In the meantime the industry is concentrating on rebuilding capital. Practically all of Big Kat’s victims have gone looking for new capital. XL announced plans to sell approximately $2.15 billion worth of ordinary shares to help replace its $2.33 billion hole. Other Bermuda insurers that are also raising funds include PartnerRe, Everest Re, Platinum Holdings, PXRE, Endurance Specialty Holdings and AXIS Capital.

Considering Lloyd’s $5 billion loss, the London market has been remarkably active with most Syndicates announcing plans to increase capacity for 2006; some, such as Hiscox Plc, even upped this year’s capacity.

But where the Lloyd’s companies have really been active is in the formation of new, Bermuda subsidiaries. The biggest is from Amlin Plc, (Syndicate 2001). It’s forming a reinsurance company with an initial capitalization of $1 billion, which will operate independently of Lloyd’s. Hiscox is in the process of forming a Bermuda subsidiary, capitalized at $500 million, which will “write a balanced business mix of reinsurance and retail business.” Several other Lloyd’s companies have also launched similar initiatives.

Chubb Corp., long a critic of Bermuda companies, has decided if you can’t beat them join them. It’s entered into a deal, probably in the works before the hurricanes, with investment firm Stone Point Capital to establish Harbor Point Capital in Bermuda. The new company will acquire the ongoing business of Chubb Re Inc., including renewal rights.

New companies funded from the U.S. include: New Castle Re, formed by Citadel Investment Group, with an initial capitalization of $500 million; Validus Reinsurance Ltd., led by ex-Marsh CEO Jeffrey Greenberg, who expects to raise around $1.5 billion; and Arrow Re, set up by Arrow Capital, owned by investment bank Goldman Sachs Group.

The new companies aren’t as numerous as the ones established after Sept. 11 and their capitalization is generally less, but they will bring some new capacity to the market.

Industry faces an uncertain future

The reinsurance market’s future is also uncertain because the rising premium levels are bound to spur companies and groups to seek alternative ways of covering their risks.

“The industry is struggling right now to see what this loss really means in order to see what their future plans are,” Walther said. “The monoline companies will increase their rating criteria, but what they’re really uneasy about is how much more turmoil there may be in the marketplace. I think this [hurricane] season has scared a lot of people.”

Given the current 10 to 20 year cycle (referring to the warm period in the Atlantic) many companies are reluctant to commit capital, he said. They’re properly concerned. There were four major storms in 2004, three in 2005. What’s in store for 2006, 2007 and beyond? “Potential investors have to wonder,” he said.

Topics Trends Catastrophe Profit Loss Excess Surplus Reinsurance Hurricane Lloyd's

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