Tale of two markets: the buyer's level of U.S. catastrophe exposure has much to do with the price of reinsurance this year.

Speculation was rife in the property/casualty markets about the impact of last year's record-breaking hurricane season on reinsurance treaties at the January renewals. As reinsurers studied the data on renewals, brokers saw a "tale of two markets" unfolding.

The "two markets" phrasing came from Grahame Millwater, chairman and chief executive officer of broker Willis Re. In a foreword to his company's "Re-View" report on January renewals, Millwater wrote that reinsurance lines directly affected by hurricanes Katrina, Rita and Wilma were "in significant turmoil and undergoing major revisions of terms, conditions and structure." Those lines include retrocession, marine, energy and U.S. property.

Other property/casualty lines, while experiencing a sort of arrested development in terms of the softening that had occurred over the previous 18 months, were best described as "stable" rather than "hard," said Millwater.

Millwater ticked off several reasons for pessimism about the strength and duration of any hardening of prices and terms for reinsurers, despite the estimated $50 billion or more in insured catastrophe losses for 2005. Among them were the following:

* Rating agencies are imposing stricter standards for insurers to reserve against major losses;

* Catastrophe models are being fine-tuned to encompass bigger risk scenarios;

* In contrast to their conditions at the time of the Sept. 11, 2001, terrorist catastrophe, insurers and reinsurers are now in a much stronger capital position; and

* Insurers are less willing than in the past to risk their capital positions for market share.

From the vantage point of London, last year's major hurricanes in the United States had a relatively subdued effect on reinsurance renewals.

Charles P.T. Cantlay, deputy chairman of Aon Re U.K., described the upward pressure on the Jan. 1 reinsurance renewals as "very narrowly focused" on such U.S. lines as property, retrocessional, energy and marine. For these categories, Cantlay told a press briefing at Aon's London offices, "it has probably been the most difficult season in many, many years. Apart from [those], it was flat."

"This is very much a two-tier market," Cantlay said.

Cantlay also pointed to wider factors. He said it may appear the $80 billion in losses generated by last year's U.S. storms would have a major effect on the industry. But he noted that $50 billion of this wound up in the reinsurance market and that large amounts of capital quickly flowed into the business. This made "significant capacity" available, Cantlay said.

Cantlay added that Hurricane Katrina, unlike the 2001 terrorist attack on the World Trade Center, followed a healthy period in the industry. He noted that three years of profit had preceded 2005, and good reserves were in place.

Earnings vs. Capital

"This was substantially an earnings event, not a capital event," Cantlay said of the 2005 U.S. losses. Aon Re U.K. is part of Chicago-based Aon Corp.

Guy Carpenter & Co.'s chief economist, Sean Mooney, used identical phrasing to describe the effects of the 2005 events. "In general, there was plentiful capacity available at Jan. 1 renewals," said Mooney. "A major exception was in property catastrophe, particularly in higher layers, roughly corresponding to hurricanes with Category 3 or higher severity."

The question was whether reinsurers would be willing to sell at prices lower than they wanted, even as primary insurers weren't as inclined to pay higher reinsurance prices as in the past, given their stronger capital positions. Mooney noted that the U.S. insurance industry had a "spectacular" underwriting gain of $37.7 billion, excluding catastrophe losses, in 2005, up from a $5.5 billion gain in 2004. In each of the five years prior to 2004, the industry registered underwriting losses.

"It is unlikely that we will see a hard market across all primary lines of business, which one would normally expect to follow losses of this magnitude," said Mooney. "As a result, many primary insurers have not been inclined to accept rate increases across the board for reinsurance protection, since it would be difficult to pass these costs on to insureds."

Russell Merrett, treaty underwriter for Lloyd's underwriter Hiscox plc in London, found a clear difference between U.S. and non-U.S. business. "I think the biggest factor was that the main Continental reinsurers chose not to push for price increases," Merrett said in a telephone interview. As a seller of reinsurance, he expressed disappointment that the U.S. hurricanes didn't drive up rates across the board. He said there was ample room for price increases in Scandinavia, France and Asia.

Merrett also pointed to the successful resistance by European reinsureds to the idea that they effectively should pay for U.S. claims. He said this argument also worked in areas of the United States that weren't hit by the hurricanes. But Merrett dismissed the idea that the credit for this success was due to the skills of the brokers in holding the line for their clients.

London-based reinsurance broker Benfield Holdings Ltd. also noted the discrepancy between reinsurance rates in the United States and those elsewhere. "As anticipated, rates increased dramatically in the U.S.A., particularly for loss-affected areas," Benfield observed in "Swings and Roundabouts," its assessment of the 2006 renewals. "Elsewhere the initial reaction appeared to be muted, but in fact there has been a significant upswing given the previous downward trend."

According to Guy Carpenter, pricing in the property catastrophe market was "unsettled," with wide divergence between what insurers wanted to pay and what reinsurers were willing to accept. Pricing increases ranged from 10% to 100%, indicating "considerable disparity" depending on hurricane exposure and national-vs.-regional accounts.

Willis Re found that price increases for U.S. accounts hit by hurricane losses were significant, between 30% and 100%. U.S. and European accounts for property catastrophe that had no losses in 2005 saw generally small increases, and many Asian accounts were flat.

For nonmarine specialty lines, property catastrophe rates were up as much as 40%, said Willis Re. Most U.S. casualty lines were flat, while European pricing was flat to lower from a year ago, Willis Re said. Exceptions were U.K. casualty lines, with 10% to 15% rate increases.

Mooney said he didn't detect any notable changes in terms and conditions this year, compared with January renewals in 2005. "Cedents continued to have some success in expanding occurrence definition from 72 hours to 96 hours," he said.

Merrett did note with approval that the market "hardened considerably" during the last week of 2005. "Through the first few weeks of 2006 we have seen that trend continuing," he said.

Cantlay said a lot of people were shocked at disparity between the size of last year's losses and the much lower numbers that came out of the forecasting models the industry had used. He said one conclusion from this is that some insurers didn't have enough cover. "Reinsurance always is a mixture of supply and demand and the cost of capital," Cantlay said.

Merrett also looked for relief in the form of "seasonal bursts of activity" from the Asian reinsurance renewals that fall due on April 1. "I think that we will see more of what happened at the first of January," he said. "A modest hardening, even though perhaps a much bigger rise can be justified."

Things aren't likely to improve substantially until reinsurers make sure they are charging adequate prices, Merrett said. He argued that if the market isn't willing to pay, the reinsurers should reject the business.

A Local Business

The reinsurance market is subject to regional pressures, Merrett said. He pointed out that the same reinsurer can offer highly competitive rates in Asia, for instance, while taking a tough line in the United Kingdom. Had it not been for the U.S. hurricanes, Merrett said, premiums would have been under downward pressure, "however unjustified."

Alastair Speare-Cole, head of direct reinsurance for Aon Re U.K., also noted the importance of local market conditions. He told the Aon press briefing that big increases in French motor, for instance, owed much to the level of reserves in France, while a rise in U.K. motor was influenced by claims inflation.

Most reinsurers have been holding comment on their January renewal results. French insurer Scor S.A. released a short statement saying it anticipated a 25% increase in worldwide premium income for its nonlife and credit and surety lines coming out of January renewals. Scor cited strong premium growth in the United Kingdom, Europe and Asia, but the reinsurer has little exposure to the key U.S. market and was little affected by last year's hurricanes, making it a poor barometer for those reinsurance lines most affected by 2005 events.

Aon was surprised at the number of start-ups that followed the U.S. hurricane activity, Cantlay said. While not all of these were catastrophe driven, he said, there was good overall access to funds. "There is a lot of capital sitting out there with hedge funds and in other places, hoping to find a home," he said.

Mooney also noted a "prominent role" by hedge funds in providing capital for startups this year. "We also have the emergence of what we call 'converters,' facilities that can readily transform insurance risk into capital market risk," said Mooney. "Hedge funds have shown the lead in this field."

Lines Hit Hard

The following reinsurance lines were hit hardest by hurricanes Katrina, Rita and Wilma and therefore experienced the greatest price increases and policy revisions. U.S. property U.S. retrocessional U.S. energy U.S. marine

* Reinsurance lines directly affected by hurricanes Katrina, Rita and Wilma are undergoing major revisions of terms, conditions and structures.

* Hurricane Katrina, unlike the 2001 terrorist attack on the World Trade Center, followed a healthy period in the industry, and thus impacted earnings more than capital.

* Many primary insurers have not been inclined to accept rate increases across the board for reinsurance protection.