Retrocession Extinct?

The retrocessional market is still tight and, because a limited number of players control the availability of capacity, there is discipline over pricing,” says James Illingworth, managing director of “business intelligence monitoring” at Amlin, a leading Lloyd’s of London underwriting business. “There is virtually no second-tier cover, other than at a very high level or through alternative products. That means a portfolio of inwards retrocessional business is basically unprotected. This capacity constraint helps to maintain discipline amongst primary reinsurers as there is little opportunity to arbitrage.”

Catastrophic losses in the second half of 2004 are having a noticeable impact on pricing trends in the retrocession market. Until those losses occurred, rates had been easing slightly. Specialist reinsurance broker Guy Carpenter has estimated that property catastrophe retrocession prices eased by “around 10%, dependent on exposures” for the 2004 renewal. Global broker Benfield Group has said that risk-adjusted “rate-on-line pricing” for worldwide retrocession covers fell by under 5% in 2004, while for U.S.-only exposures prices fell by more than 5%. Worldwide covers, excluding U.S. exposures, were fairly static over the same period. Cedants without U.S. exposure achieved better value of between 5%-15% against the increased exposures within underlying portfolios.

TOUGHER TERMS

Prices stabilized following the 2004 renewal, however, and losses arising from recent land-falling Atlantic hurricanes and Japanese typhoons appear set to reverse the trend for 2005. Underwriters are reporting firm pricing, with increases on the agenda for many programs, especially those which have been impacted by Gulf storm losses in Florida or the Caribbean. Despite early indications that hurricanes Charley, Francis, Ivan, and Jeanne would not result in major retrocessional losses, escalating claims experiences are causing retrocessionnaires to reassess the cost of the storms, and the price implications for the 2005 renewal.

“Whilst the direct reinsurance market is up and running with firm orders flowing in thick and fast, the retro market is as late as ever,” says Andrew Carrier, head of reinsurance at the Kiln Group, another Lloyd’s underwriting business. “A particular feature of this season is the ‘creep’ we are witnessing on some of the catastrophe losses.” In late September, in the immediate aftermath of the storms, received wisdom had it that, in general, the resulting reinsurance claims would not impact retrocession programs to any major extent, he notes. “It is now becoming clearer that Charley and Ivan may impact the retro market rather more than at first appeared,” Carrier adds. “It may be that retro underwriters are making sure they really have got a handle on the scale of the losses before quoting.”

UNDERWRITING SPREADS

Analytical underwriting diligence on the part of retrocessionnaires is a broadening phenomenon. The era of “carefree retro underwriting” ended several years ago, and today the small retrocession community, which is dominated by a handful of risk carriers and only a few hundred individuals worldwide, is more technical than ever. “Retrocessional writers require large amounts of information on the portfolios of business written by their clients,” Illingworth observes, “this higher level of transparency enables them to adopt a more sophisticated approach to pricing and managing their exposures”.

Retrocession underwriters now typically conduct sophisticated modeling of exposures, especially for North American risks, so it is essential that ceding companies are able to provide high-quality data. Those reinsurers providing the most robust exposure information may see pricing benefits, since retrocessionnaires will be able to limit the loading for uncertainty. Reinsurers who are unable to provide adequate data may have to resort to the purchase of “industry loss warranty” (ILW) contracts, which are underwritten by the majority of traditional retrocessionnaires. Such instrument are also a useful addition to indemnity-based retrocession.

As retrocessionnaires demand more information and subsidiary reinsurance companies pool exposures through parent entities, the global community of retrocession buyers has contracted. However, some of the largest buyers of retrocession have purchased more in recent years, and some newly-established companies have bought meaningful programs. As well as providing an effective tool for balance-sheet preservation, retrocession can meet rating agency expectations about prudence, and can provide earnings and dividend protection.

EXPANDING MARKETS

The global retrocession market generates premiums of about $2 billion annually, although the confidentiality surrounding most contracts makes firm estimates difficult to muster. Capacity has expanded slightly over the past two years, especially for traditional, non-structured retrocession. One capacity driver has been the entrance of hedge funds into the ILW market, and increasingly, as suppliers of traditional retrocession products. Another has been the entrance of newly-launched Bermuda-based risk carriers.

Nonetheless, there is far from a glut of capacity in the global retrocession marketplace. “Cedants in the retrocession market are wise to remain loyal to their current reinsurance panel, given the thinly populated nature of the market,” says Dominic Christian, a retrocession broker at Benfield. “Retro continues to attract some of the smartest players in town, but there are only a dozen meaningful players in the market, and perhaps forty in total who are active.”

Despite these minor fluctuations, the retrocession market has been much less cyclical than other risk transfer arenas, in part because of this small number of major active sellers around the world. “It may come as a surprise to some observers that the retrocession market has been remarkably stable over the last several years,” observes Russell Merrett, a lead reinsurance underwriter at Hiscox Syndicate-33 at Lloyd’s. “There are few lead markets but, almost without exception, the small number of individual underwriters who shape the market have been in place for many years. As a buyer we feel that we have seen reassuring continuity from our retrocession partners, and enjoy a sensible dialogue regarding terms and conditions.”

Merrett, who is also chairman of Lloyd’s “Market Association’s Reinsurance Business Panel”, does not anticipate significant shifts in the retro market in the months ahead. “Inevitably there are some new entrants to this profitable and disciplined market niche, and this may put some pressure on pricing. However, we are not expecting major changes, and look forward to continuing to hedge our worst-case scenarios with our retrocession partners as part of our overall risk management strategy.”