By way of contrast, international and, in particular, European pricing
has not steadied and prices continue to fall and limits and deductibles remain inadequate.

2005 saw four of the most costly insurance losses of recent times : Hurricanes Katrina, Rita and Wilma in the US and Winter Storm Erwin which affected Northern Europe. Damage from the three US hurricanes is estimated to have cost the insurance industry not less than $65bn. Given the level of destruction, it is perhaps not surprising that the damage from Erwin (c. $2bn) has not had quite the same attention.

The impact of the three ugly sisters on property catastrophe reinsurance pricing has taken its toll since the start of the year. Ascot Underwriting Ltd has seen overall pricing more than double on our Energy, Property and Treaty accounts (all of which are significantly influenced by Gulf of Mexico and Florida exposures). As well as changes to pricing, we have also seen significant restructuring of programmes and reduced peak exposures, but the campaign for better granularity of data continues. This granularity will allow us to significantly increase the precision with which we measure our aggregate exposures and consequently maximise the amount of aggregate we have available for a given risk. Lack of data should not be used as a competitive advantage by those insurers who are less stringent in this regard.

By way of contrast, international and, in particular, European pricing has not steadied and prices continue to fall and limits and deductibles remain inadequate. How to explain the difference? Europe is certainly a more benign catastrophe risk than the US but as Erwin demonstrates, the risk of catastrophic loss is very real. Flooding in Europe, for example, is a significant exposure, the Central European Floods last year caused total damage of more than $3.3bn and headlines like, “Europe counts cost of flood chaos” were in the news. These floods were not one-offs; the last decade has seen floods in the Elbe and Danube rivers in August 2002, the UK floods in 2000, the Oder flood in 1997, and the Rhine/Meuse floods in 1993 and 1995. In fact a recent European Commission report concluded that: “flood magnitude and frequency are likely to increase in most regions, and low flows are likely to decrease in many regions.”

Pricing in international markets seems not to be driven by sensible underwriting or indeed relationship underwriting but is everything to do with US capacity constraints. To put it simply, international risks are the counter balance to US aggregates as insurers aggressively chase uncorrelated exposures.

As a result, prices are driven down. This cannot be sustainable. However, while there remain markets relatively unaffected by the US cat losses last year (and this is certainly the case for some of the large regional players in Europe and the Far East) and while there continues to be reinsurers happy to support price reductions through their Quota Share treaties, then the international market will continue to get more and more out of kilter with the US and with the global reinsurance markets.

Like many of the Lloyd’s syndicates present at Monte Carlo this year, we are looking at the current reinsurance market from the perspective of both buyer and provider. The main consideration for us is that while reinsurance prices in the US appear high, there remains a shortage of available capacity for US catastrophe business. Indeed retrocessional capacity remains extremely tight and all markets are having to bear significantly larger retentions and look at innovative forms of protection: increased use of Industry Loss Warranties (ILWs) and/or collateralised protections, etc. Although this year has seen the emergence of a number of “side-cars” (these post- Katrina Bermuda-based sidecars will soon have raised more than $2.5bn in capital ), the early signs are that, for many, income is unlikely to meet initial expectations. In that climate it seems highly unlikely that US peak prices will fall in the short or medium term. Indeed, a recent analysts report suggested that US property catastrophe reinsurance rates would rise at least 33-75% for peak zone exposed programmes at January 1st, irrespective of the hurricane season, as rates catch up to current levels.

My view is that the current differential between international primary markets and reinsurance and retro markets cannot continue. As the retrocessional squeeze starts to impact on reinsurers, there will be a knock on effect on international primary markets. Primary insurers currently seem happy to accept their returns being eroded (the 1st April Asian renewals and the 1st July renewals saw significant competition for business), this despite insurers also being subject to higher capital requirements from the rating agencies and modelling companies. This puts many local markets in a precarious position: the limited number of catastrophe markets means that any material loss would be felt immediately and be painful. Perhaps these markets believe that the reinsurance and retro squeeze is just a blip? It is not: international primary insurers need to recognise that the impact of the US hurricanes has been profound and far reaching. Whether risks are located in Houston, Hamburg or Hong Kong, the real cost of risk is now more expensive.

This Special item appeared in issue 108 of JTW News - September 2006

Author: Martin Reith - Ascot Underwriting