The Willis View - A Tale of Two Markets

Hurricanes Katrina, Rita and Wilma have left part of the insurance and reinsurance world reeling. I deliberately say 'part' because currently, we have reinsurance markets such as retro, marine, energy and US property in significant turmoil, and undergoing major revisions of terms, conditions and structure. However, while generally we have seen an end to the 'softening' of the past 18 months in other parts of the reinsurance market, the environment is best described as 'stable' rather than 'hard'.

The question is whether this 'Tale of Two Markets' is temporary, or will be sustained - but first, one has to consider the backdrop. Certain factors would suggest that these conditions are temporary. While rating agencies have naturally focused their efforts on those companies suffering significant losses and/or starting up, their changed requirements in respect of the increased capital deployed against given loss scenarios will affect the insurance and reinsurance sectors globally.

Also, as catastrophe models are recalibrated to incorporate more aggressive assumptions regarding potential losses, these will impact across the world. We must also remind ourselves that while hurricane-loss estimates are extremely high, the values actually paid to date are currently still relatively small - though the actual pain of significant outflows of cash is always a reality check.

An end in sight?

However, there are also factors that suggest any hardening trend will be limited. When the World Trade Centre disaster occurred in 2001, the insurance and reinsurance balance sheets were generally in poor shape. This contrasts with 2005, where, prior to the hurricanes, balance sheets were strong, and combined ratios were healthy and improving. The hurricanes have severely damaged the financial health of certain US insurers, specialty line underwriters and many reinsurers, but outside of that, insurers have had several good years, and therefore appear reluctant to risk losing market share by striving to increase prices

Additionally, there is new capital arriving in the form of recapitalisation of existing participants, new start-ups and new types of structured products. The hedge funds are major players in all of these areas, and these are here to stay in some form. This new capital will provide a fresh supply of capacity, and will be encouraged to write business outside the distressed market, if for no other reason than the rating agencies are looking for the markets to diversify.

The fundamental trends cannot be ignored, however. Sources of risk are increasing; the frequency and severity of catastrophes seem to be rising; and the values at risk increase not only with urbanisation and infrastructure development, but with increased penetration of the insurance product.

Consequently, rating agencies, risk modellers, and reinsurance companies are going to require more transparency, analysis, exposure control and structural clarity. These will not be localised phenomena, but will be global requirements, which will undoubtedly impact the reinsurance structures of our clients around the world. Willis Re remains committed to helping our clients navigate this increasingly complicated and sophisticated environment.

From Willis Re-View @ 1.01.06

CHRIS CLARK, CEO WILLIS RE SPECIALTY

"Specialty lines, particularly marine, energy (whose results, certainly on a gross basis, will be the worst ever on record) and retrocession, have been catastrophically impacted by the hurricanes. Going forward, there is an urgent requirement for transparency. The fact that the models failed to predict accurately how much damage a large hurricane would wreak going through the Gulf of Mexico means that greater clarity is necessary as to the precise nature of the risk underwriters are asked to reinsure.

"The markets also need a 'miss' factor, either by peril or territory, so that their entire aggregate is not impacted from a single event. Pricing and negotiations in the specialty areas have clearly been dominated by the Gulf of Mexico storms.

"Adjustments are also being made by the direct market cutting out classes such as contingent business interruption and aggregate wind-combined single limits on insureds, also by increasing deductibles and waiting periods. The issue of wind in the Gulf of Mexico can, to an extent, afford to wait for resolution being achieved in the New Year in time for when it becomes a risk in June 2006.

"Aside from this exposure, rates are increasing and conditions being tightened in every area of the specialty book, which reflects the increased cost of reinsurers' capital. In sum, the 2006 hurricane season will be pivotal to the long-term future of the specialty market."

From Willis Re-View @ 1.01.06

JAMES VICKERS, CEO, WILLIS RE INTERNATIONAL

"Rate increases have tended to be most significant in areas of high catastrophe demand, but outside of these peak areas, reinsurers have shown varying attitudes toward the value of diversification.

"Some reinsurers have been prepared to support lower rate increases or flat renewals outside peak territories, whereas others have stuck to a tougher pricing line, and as a result will enter 2006 with less well-diversified portfolios.

"However, with adequate capacity supply, most buyers have tended to support their existing reinsurers, leaving limited opportunities for new reinsurers."

From Willis Re-View @ 1.01.06.