MIAMI—A changing insurance and reinsurance market means captive insurance company owners should be prepared for higher prices for fronting and reinsurance coverage as well as the possibility of capacity becoming harder to find.

Meanwhile, buyers will need to step up their own games in seeking the most favorable contracts possible and closely scrutinizing the security of fronting and reinsurance coverage providers, according to two speakers providing a fronting and reinsurance market update at the World Captive Forum, held last week at the Doral Golf Resort & Spa in Miami.

Brian First, executive vp and chief underwriting officer at SPARTA Insurance Co. in Hartford, Conn., noted that 2011 was marked by considerable discussion of pressure on insurance industry fundamentals fueled by such factors as an ongoing soft market, poor investment returns and a weak economy depressing insurance demand.

On top of that, prior-year reserve releases that had bolstered many insurers' results in recent years are now largely tapped out.

Meanwhile, there were $100 billion to $120 billion in insured catastrophe losses in 2011. “More importantly,” Mr. First said, the average number of catastrophes was up 30% over the past three years compared with the 30-year average, while average losses over the past three years were three times the 30-year trend.

The outlook for 2012, he said, shows more of the same.

“The cookie jar is basically empty. The well is dry on reserve releases,” Mr. First said. “The warning signs in the industry from 2011 have become emergency flashers.”

The result is that, in 2012, insurers and reinsurers are likely to demonstrate an increased focus on underwriting profitability and risk selection, as well as opportunistic rate increases and book management, Mr. First said. Insurers will be willing to walk away from business where they can't get adequate price, he said, while noncore business units and products will be closely scrutinized.

There also are likely to be attempts by insurers and reinsurers to limit capacity and address concentrations of risk and tighten terms and conditions, and there will be less creativity and customization of products.

Mr. First noted that the market is generally firming now with increases of zero to 5%, and 2012 events could lead to broader market hardening with rates increasing 10% or more and a lack of available coverage.

“If you're a good account and you're flat, that's probably as good as you can expect as we go through 2012,” he said.

He suggested that captives, as well as other insureds, prepare for market disruption, with price increases in primary and excess layers and revised terms and conditions. In addition to price increases, fronting customers also are likely to see more restrictive collateral terms and collateral releases.

With the market changing, companies without captives should consider forming them, he said. “It's the time to dust off your captive proposal if you already have one,” Mr. First said. Companies that already have captives, he said, “should be insulated from a lot of the factors I talked about, but you won't be isolated from them.”

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Discussing some of 2011's major losses, Michael Woodroffe, president of intermediary Kirkway International Ltd. in Pembroke, Bermuda, said that as bad as losses were from the March 2011 earthquake and tsunami that hit Japan, reinsurers had priced appropriately for those catastrophes.

“The good news about Japan is, yes, they had a bad earthquake, but they pay a lot” for the coverage, he said.

Reinsurers' experience with flooding in Thailand was a different case, however, as final costs are still being tallied and it's becoming apparent the reinsurance market was taken by surprise by the scale of the loss, Mr. Woodroffe said. “I would imagine the Thai renewal season will be fairly bloody.”

In the current environment, Mr. Woodroffe advised captives buying reinsurance to “buy long” and purchase multiyear reinsurance contracts. “What's amazing is (the) reinsurance (market) is still willing to sell you this,” he said.

He also advised captive owners to lock in aggregate reinsurance protection, where possible, to protect against adverse developments from rising loss ratios across all lines of coverage.

And he told the owners to stick to flat-rated contracts and avoid swing-rated deals where premium is dependent on loss experience in order to avoid a “double-whammy” of experiencing deteriorating loss results while being hit with additional reinsurance premiums.

Swing-rated deals are “a real con trick in the classic way,” Mr. Woodroffe said. “The maximum rate will take you down. You can't afford to pay the maximum rate.”

Mr. Woodroffe said captives should insist on purchasing reinsurance separately rather than buying bundled services. “The whole point of having a captive is to have control of your destiny,” he said. “Divide and conquer. The reinsurance guys will police the front guys.”

And he stressed the importance of fronting insurers' and reinsurers' security. Captives must carefully review fronting insurers' security, he said. With reinsurers, “security's everything,” he said, advising buyers to avoid weak balance sheets, legacy issues and companies with no long-term capital commitment. And he advised captive owners to stick with trusted reinsurers with whom they have built a “bank” of premium.