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Reinsurers’ tough talk about raising prices on the risk cover they sell to insurers may have rung hollow before, but this time the promise is credible.
Reinsurance companies such as global leader Munich Re have been flexing their muscles, predicting that the damage to insurers’ investment income and capital base from the financial crisis means they have to pay more for cover.
“The turnaround has been achieved,” Torsten Jeworrek, Munich Re board member in charge of reinsurance, said this month, adding that the price fall of the last few years had been stopped.
“There is a very strong expectation of further price increases during the course of the year,” Jeworrek said.
Munich Re was the first to predict the financial crisis would lead to a price surge, but other reinsurers chimed in, with some forecasting double-digit percentage gains in premiums.
Reinsurers have vowed discipline on pricing in the past, only to slide into competitive price wars to seize or defend market share, sacrificing profitability for volume.
This time may be different, says industry observers.
“Overall, we have seen very disciplined behaviour from reinsurers,” said Michael Handler, chairman for continental Europe at reinsurance specialist Guy Carpenter, part of the world’s biggest insurance broker, Marsh.
“I expect a price increase in the teens in the course of the year. There are always exceptions, but this is the trend.”
WEAK CAPITAL BASES
The financial market meltdown has prompted writedowns and drained investment income at insurers, siphoning off some of their equity capital base and limiting their ability to underwrite risks without help from reinsurers. “The financial strength of companies is a major issue at this stage, which it has not been for a very long time,” Handler said, adding that the crisis meant no outside capital was available to take on reinsurance risks as in the past.
Reinsurers’ upbeat outlook has helped underpin their shares over the last six months, with Munich Re flat, world No. 5 player Scor down just 2 percent and No. 4 reinsurer Hannover Re down 8 percent, compared with a 43 percent drop in the DJ Stoxx European insurance index.
“From an investor point of view, you have the feeling that reinsurance is a genuinely defensive sector,” said Collins Stewart insurance analyst Ben Cohen.
“You are looking at ROEs in the low to mid-teens in 2009, and there are not many other financial stocks where you can be confident that what they are earning will be distributed to shareholders over a short time horizon.
According to StarMine, which weights analysts’ forecasts by their track record, Munich Re trades at 7.8 times 12-month forward earnings and Scor at 7.9 times, a premium to insurers Allianz and AXA, which trade at around 6.
Cohen said he pencilled in percentage price rises in the high single digits or low double digits in the next big reinsurance contract renewal talks in April and July.
“If the economy is tough, with low underlying growth, you may not see all of it in companies’ top lines,” he said.
OLD HABITS
Even so, there are still some who doubt reinsurers’ resolve in delivering a “hard market”, where reinsurers’ prices and conditions improve relative to their insurance company clients.
JP Morgan analyst Michael Huttner said the damage to insurers’ balance sheets from the financial crisis might not be enough to allow reinsurers scope for big price increases without big natural catastrophes such as hurricanes or earthquakes.
Economic downturns in the early 1990s and the burst dotcom bubble at the start of this decade created hard markets only after catastrophic events occurred such as Hurricane Andrew in 1992 or the Sept. 11 attacks on the United States in 2001.
“We haven’t lost enough on large natural catastrophes to create the immediate surge in demand that you need to get into a full-blown hard market cycle,” Huttner said.
“Pricing will probably be flat for the next few months, until we get a signal for more firming, and that signal would come from increased demand after a big nat. cat.,” Huttner said.
And tighter budgets may mean insurers buy less reinsurance, muddying the impact of higher prices on reinsurers’ bottom line.
“There is not a lot of excess reinsurance premium around,” said Guy Carpenter’s Handler. “People are retaining more risk and buying less reinsurance at higher prices,” he said.
(Editing by Simon Jessop/Will Waterman)