Reinsurance Rendezvous Focuses on Euro Zone, Interest Rates, Capital

By Charles E. Boyle | September 10, 2012

For once there’s no natural catastrophe hanging over the annual Reinsurance Rendezvous in Monte Carlo (the 56th edition). Tropical storm Leslie missed Bermuda and Hurricane Michael is safely out in the Atlantic. But that doesn’t mean there are few concerns for the more than 3000 insurance people, accountants, lawyers and the press that are gathered in the resort to learn and play.

The industry’s main concerns are economic. The ongoing financial crisis in the euro zone has created so much uncertainty over its eventual outcome that re/insurance markets around the world have been affected. Interest rates, especially on highly rated government bonds, remain so low that making even a marginal profit on investments is becoming almost impossible.

Reinsurance pricing is being affected by the amount of capital available. Most traditional reinsurance providers have more than they can use, and the capital markets now add approximately 14 percent more, mostly in the form of cat bonds and sidecars.

Torsten Jeworrek, Munich Re’s Reinsurance CEO noted in a press release: “More than ever, our industry faces the challenge of achieving stable earnings in its core business and further reducing its dependency on the investment result. The key question will be how quickly and to what extent insurers and reinsurers will succeed in factoring the low interest-rate level into their price calculations.”

Michael O’Halleran, Executive Chairman of Aon Benfield, described investment returns as “pathetic.” He also said “buying trends in the casualty sector continue to decline, while property is going up.” While earnings are still fairly good, especially given the so far benign year for catastrophes, O’Halleran noted that they have been supported by reserve releases, which are likely to become less frequently available.

Most of the comments on the soft/hard market cycle centers on the fact that premium increases in recent years have been limited to areas where significant loss events occurred – the Japanese earthquake and tsunami; the New Zealand earthquakes, Australian and Thailand floods. The often voiced opinion is that the market “needs a really big – $60 billion or more – catastrophic event before rates will go up.” Considering that the events in 2011 cost the industry $105 billion, yet rates only rose in certain sectors, even that scenario appears unlikely.

Both A.M. Best and Standard & Poor’s briefing sessions included an analysis of sovereign debt levels in general and the euro zone crisis in particular. Italy, Ireland and Portugal all have debt levels that are at or near 120 percent of their GDP, while Greece’s debt is 160 percent of its GDP, explained A.M. Best Europe’s managing director Stefan Holzberger.

Conversely, Spain’s Government debt level for 2012 is estimated to remain at around 80 percent of GDP. The country’s economic crisis is largely due to the real estate bubble and the related losses incurred by Spanish banks, raher than government spending. Nonetheless, it is severe, causing negative growth and very high unemployment levels. 

As a result the economies in these countries, and in most of Europe, are growing very slowly, if at all. Many of them are in recession. While the solution – a fiscal union with a strong central bank – is in front of everybody’s nose, it remains tantalizingly out of reach. “The strong words haven’t been backed up by equally strong actions,” said Holzberger.

Paul Sheard, S&P’s executive managing director, chief global economist and head of global economics and research, put the current crisis in perspective. It’s “no ordinary cycle,” he said; “it’s the biggest since the [1930's] depression.” He noted that U.S GDP declined by 4.7 percent, but has struggled back to 1.7 percent above pre-crisis levels and seems set to continue to grow slowly. Germany’s GDP declined by 6.7 percent, but has recovered to higher levels. In contrast Sheard said: “Italy’s GDP went down by 7.1 percent and is still 6.8 percent less than pre crisis levels.”

He explained that the cause of the crisis is the “economic architecture of the euro zone,” which had undertaken “monetary union,” but failed to establish a “fiscal union,” which would have economic control over the euro zone’s 17 members. “You can only reduce the monetary component [i.e. break up the euro zone], or increase the fiscal one” in order to reach a solution.

Sheard said he is a bit more hopeful after the statement by EU President Von Rompuy that an economic and fiscal, as well as political union is a long term plan for the euro zone and the recent actions of the European Central Bank. But national political considerations have always been, and remain, the chief stumbling block to achieving that union. In addition “a ten year plan is fine,” he said, “but economies run on a day to day basis.”

Sheard’s analysis didn’t spare the U.S. either. He pointed out that the “fiscal cliff” – the scheduled massive cuts in government spending, accompanied by the restoration and resulting increase in tax rates – slated to come into force early next year, if they are enacted, would probably result in a 3.4 percent decline in U.S. GDP. That would be catastrophic, throwing the U.S. back into recession, stifling growth and increasing the already high [app. 8 percent] unemployment figures.

 ”It’s a really silly thing to do,” Sheard said. As a result he and other economists expect the president and the Congress to come to some agreement to at least postpone the imposition of the radical changes, if not to adopt a more sane policy.

Given the fact that the inability of the two government entities to agree on anything like a common economic policy, which created the “fiscal cliff” in the first place, that’s staking a great deal on their ability to bury their political differences for the good of the country.

 

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