in excess-of-loss coverage rates of up to 20%, while ceding commissions for third- party liability lines have increased by as much as 7%. These trends extend to many other lines of business and regions as well, though to a lesser extent (see Table 2). If falling underwriting profitability—a key component of operating performance and ultimately a reinsurer’s competitive strength—continues to drop this sharply, or if the slide in rates becomes more widespread, the weakened earnings power could affect Standard & Poor’s Ratings Services’ views of reinsurers’ business risk.
What’s Happening In Florida?
Rates on Florida property-catastrophe reinsurance have dropped the most sharply, between 15% and 25% during the most recent 2014 renewals. And the largest decreases may have been for some of the riskier accounts, because market pressure can cause underwriters to differentiate less between the best and worst accounts in the prices they charge. The shifts in pricing have caused at least one notable catastrophe reinsurer, Validus Holdings Ltd., to note that it no longer views its Florida property catastrophe market as the most profitable region. Although this stance is controversial given other participants’ views of the Florida market, it indicates how significant the pricing impact may be. Although some underwriters may have refused to drop prices as far as brokers have requested for certain deals, we expect the imbalance of supply and demand to continue to push rates down for upcoming renewals.
We see three primary reasons for the strong pressure on property catastrophe rates in Florida (and, to a lesser extent, other territories). The first is its historically high profit margins. Major U.S. catastrophe zones like Florida consume the most capital, requiring reinsurers to demand an additional return for maintaining concentrations to this specific risk. But higher returns lure more competition in soft phases of the market cycle.
The second reason is the surplus in reinsurance capital, both traditional and alternative. The reinsurance market has been accumulating capital faster than it can deploy it. Because excess supply generally causes reinsurance markets to soften, those with the highest margins, like property catastrophe, naturally attract more competition. And given that alternative
Global Reinsurance Highlights 2014
Table 1: Change In Risk-Adjusted Property Rates Territory
Pro rata commission (percentage points)
Australia Caribbean China
Europe Japan - earthquake
Japan - wind and flood Latin America Middle East South Africa U.K.
U.S. - Florida U.S. - nationwide
0 to 2 1 to 2 2
N/A 3
N/A
-2.5 to 0 0 to +1 2.5
varies 2 to 5 N/A
capital investors often have little exposure to catastrophe risk, they need not demand additional returns for concentrations to this risk as traditional reinsurers would. Finally, data on residential risks in Florida and the U.S. overall is ample and of relatively high quality, giving investors confidence that U.S. catastrophe models are more accurate than those for other territories. Many reinsurance placements covering Florida exposures isolate risk to a specific region where there is good exposure data and a history of losses against which catastrophe models can be calibrated. This comforts many investors who must rely on theoretical magnitudes and probabilities of catastrophe losses for risk assessment, and is part of the reason Florida risk appears attractive. In some jurisdictions, particularly outside the U.S., data quality or understanding of catastrophe phenomena are poor, making many investors and reinsurers wary of the concomitant risks.
The absence of a major hurricane landfall in Florida in the past eight-plus years has also boosted profitability and the perceived attractiveness of this business. However, it may lull some participants into complacency or mislead some investors that haven’t been active in catastrophe risk long enough to experience large losses.
Few Places To Hide
Although property catastrophe price drops are getting more headlines, the story isn’t much better for other lines of business. This gives reinsurers limited options for reallocating their capital. With pressure on excess-of-loss rates, some insurers have written some more pro-rata treaties (arrangements whereby the reinsurer shares a proportional amount of premiums and losses with cedants). However, the ceding commissions that reinsurers pay to cedants are rising, which is squeezing the economics for reinsurers on some deals or offsetting primary rate increases in some insurance lines, particularly in the U.S.
Waning reinsurance demand, particularly among some larger cedants, is adding to the imbalance of supply and demand. With robust capital positions of their own, some larger cedants are scaling back their reinsurance purchases, rationalizing their reinsurance panels (by choosing to work with fewer of the most important partners), and issuing catastrophe bonds as reinsurance. This favors reinsurance companies that can add value outside of capacity (through analytical services or creative product offerings) or can support cedants on multiple lines of business. However, these large cedants are still pushing for better prices, which could sideline smaller
19
% Change: catastrophe loss free -17.5 to -12.5
-15 to -10 -50 to -20 -15 to -10
-17.5 to -12.5 -15 to -10 -10 to -5
-12.5 to -7.5 -10
-20 to -15 -25 to -15 -20 to -10
N/A = Not applicable. Source: Willis Re 1st View, Jan. 1, 2014; Willis Re 1st View, April 1, 2014; and Willis Re 1st View, July 1, 2014.
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