September 1, 1999 by Sean Mooney, senior vice president at Guy Carpenter & Company In
The U.S. reinsurance industry has been stagnant for a number of years. And, although the security of the business remains exceptionally strong, industry profitability has been stable if lackluster.
The first chart below shows that the reinsurance market has been basically flat for four years. In 1998, net written premiums for the composite stood at US$17.6 billion, practically equal to the level of US$17.7 billion in 1995. Data reported so far this year indicate that the market has remained stagnant. The Reinsurance Association of America (RAA) reports an increase of only 1.1% in premiums for the second quarter of 1999.
At the time of writing, there are some straws in the wind that suggest a market turn in both the primary and reinsurance industries. In the first six months of 1999, there have been a number of substantial catastrophe losses. Winter storms in January in the U.S. cost over US$1.8 billion. A highly unusual hailstorm in Sydney, Australia resulted in insured losses of US$1 billion. Floods in Europe also resulted in significant losses. Devastating tornadoes in the spring in the U.S. heartland cost about $1.5 billion. Forecasters are projecting an active Atlantic hurricane season, with 14 named storms, more than 50% higher than the average of nine.
On the reinsurer side, the retrocession market has been very tight, forcing reinsurers to increase their net exposures. At the same time, the decline in price has pushed a number of reinsurers to the sidelines, notably in the Bermuda market. This market is highly sensitive to pressure from stock analysts, and Bermudan reinsurers prefer to maintain surplus capacity rather than deploy it at projected low rates of return.
All of these factors suggest a change. It now appear increasingly likely that 2000 renewals will face a different marketplace. On average, prices can be expected to firm, and some programs will have difficulty being fully completed. This will be a “kinder and gentler” market turn, somewhat akin to the market turn currently underway in commercial lines in the U.S. A sharp turn in market rates akin to that of 1993 following Hurricane Andrew is not anticipated, barring a mega-catastrophe, or an unusual cumulation of major disasters.
A major area of concern for both insurers and reinsurers is the possibility of claims arising form the Y2K computer bug. The general viewpoint in the industry is that claim losses arising from this source will be minimal. However, given the potentially enormous size of Y2K losses, albeit with a low probability, insurers and reinsurers will be holding their fingers tightly crossed until well into the new year.
The flat market reflects several factors, including slow growth in the underlying primary market, particularly in commercial lines, and intense competition, reflecting in part the excess capital in the reinsurance business. Consolidation of cedents has also resulted in less demand for reinsurance. Notably, acquisition activity in the U.S. primary sector was particularly lively in the first half of this year, with 15 transactions completed with a total value of more than US$100 million.
Of note, six of the acquiring companies (see list on preceeding page) are headquartered in Europe, indicating a continued desire of European insurers to grow in the U.S. market and achieve a perceived critical mass to be a survivor in the rapidly consolidating industry.
Reflecting in part the lack of internal growth, reinsurers have sought growth through acquisition. The number of professional reinsurers included in Guy Carpenter’s composite index declined to 38 companies in 1998, down from 64 in 1992. The number of companies operating in the market will likely decline further due to acquisition-driven consolidation. Indeed, in June 1999, two of the largest independent reinsurers in the U.S., Trenwick America and Chartwell Re, announced plans to merge.
The rate of return for the reinsurance industry increased to 16.9% in 1998, and exceeded the rate for the Fortune-500. However, as will be explained further on, this increase was due mainly to a special transaction by a large reinsurer. Excluding the result for this company, the rate of return actually shows a decline to 9.7% for 1998.
The loss ratio of the reinsurance industry increased to 73% in 1998, reflecting in part higher catastrophic losses for 1998 over that of 1997. U.S. catastrophe losses totaled $10.1 billion in 1998. While none of the losses in 1998 were devastating to most reinsurers, the cumulative impact on the industry was significant.
The investment earnings chart, reflecting investment income and realized capital gains, shows an extraordinary jump in the value of the industry’s investments to US$3.8 billion for 1998 compared with US$842 million for 1997. This increase mainly reflects the unusual event of the sale of a large portfolio of equities by General Re, resulting in a capital gain of US$2.5 billion.
Most reinsurers have extraordinarily strong balance sheets, resulting in under-utilized capital.
The basic indicator of financial capacity, the premium to surplus ratio, declined for the fourth straight year to 65%. This means that every 65 cents of premium is supported by a dollar in capital. This is extraordinarily low for a business where once the standard for regulatory attention was $3 in premium to $1 of surplus.
Another area of possible concern is in terms of the assets of reinsurers, particularly in regard to the risk of a decline in the stock market. However, reinsurers currently hold only 20% of their assets in stocks. Furthermore, about 60% of this total consists of investments in affiliates, the values of which are not normally subject to stock market fluctuations.
Overall, the data reviewed here lead to one strong conclusion: this is a good time to be a purchaser of reinsurance. Prices are low, capacity is plentiful and, in general, market security is rock solid. The history of the business tells us that such a situation will not persist. Some event, or combination of events, will drive capacity out of the market and cause a return to higher prices and reduced product availability. Until that time, insurers can take advantage of very favorable market conditions.
Following a lengthy period of stagnation, pricing within the U.S. reinsurance market seems to have stabilized, with even some evidence in the market of rate increases. However, until the market’s excess capacity is depleted, buyers of reinsurance will continue to enjoy the benefits of highly competitive pricing.
Major United States and Bermuda Merger and Acquisition Transactions 1999 to date
Date Target NameAcquiror Name Value of
2/15NAC Re Corp.XL Capital Limited$1,191.4 3/4Royal Maccabees Swiss Reinsurance Co. $ 387
Life Insurance Co. 5/27Capital Re Corp.ACE limited$610.9 6/22Chartwell ReTrenwick Group$230.5
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