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Reinsurers report strong results, but prices expected to fall in 2007

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WASHINGTON—U.S. reinsurers' results are expected to remain strong this year, although softening rates and an anticipated increase in catastrophes will make 2007 less of a banner year than 2006, say observers.

One unknown factor is the impact on the overall market of Florida legislation, which adds up to $17 billion in state-backed capacity for property catastrophe reinsurance buyers (BI, Jan. 29).

The 23 U.S. reinsurers surveyed by the Washington-based Reinsurance Assn. of America posted a 94.9% combined ratio for 2006, a dramatic improvement from the 129.4% reported by a comparable group in 2005.

Based on net premiums written, the top 20 U.S. reinsurers reported a 94.6% combined ratio for 2006 vs. 118.6%, which was based on a weighted average, by the same group in the year-earlier period.

Reinsurers "had a phenomenal year last year," said Adam Klauber, director of equity research for Cochran Caronia Waller, a Chicago-based insurance industry investment banking firm. "Everything really aligned for the industry."

An important factor boosting results was the absence of major U.S. catastrophes last year, say observers. Hurricanes were priced into the rates, but "that never happened," said Diane Coogan-Pushner, a portfolio manager with Philo Smith & Co., a Stamford, Conn.-based investment banking firm.

While the weather was good to reinsurers, "there was more to the story than that," including favorable reserve development for most companies and good underwriting cash flow, said Cliff Gallant, an analyst with Keefe, Bruyette & Woods Inc. in New York. "They hit on all cylinders in 2006."

In terms of nonproperty lines, however, John Gwynn, managing director at Memphis, Tenn.-based investment banking firm Morgan Keegan & Co. Inc., said most reinsurers "reported a down drift in their premium accounts," which was partially a function of price competition, "but probably more importantly, a function of increased retentions by primary companies as they got more comfortable with the profitability of the underlying business."

Catastrophes, lower prices and the possible impact of the Florida reinsurance legislation are factors that will affect 2007 results, say observers.

Reinsurers did so well last year that there is a lot more capital in the sector now, "so it's tougher to deploy," and the increased capital means more competition, said Mr. Klauber. "Rates are coming down in just about every line of business, so it's hard to put up the type of returns you did last year," he said.

"Having said that, we're still a long way off from periods in the late '90s or even early 2000s" when the underwriting cycle was at its depth. "That means returns will probably stay in the high 16% to 18% range, give or take a catastrophe here or there," Mr. Klauber said.

"The reserve positions are solid," Mr. Gallant said. "I think underwriting cash flow is good (and) investment yields are stable. The question mark is the weather."

"The absence or pickup of natural cat activity is going to set the tone for results this year," said Mr. Gwynn. "I think even if we had very light cat activity again this year, the reinsurers would have a difficult time matching last year's results, if for no other reason than the increased price softening."

How companies manage this declining rate environment is "going to be a key factor," said Mark Rouck, senior director with Fitch Ratings Ltd. in Chicago. "Companies are doing a better job managing their aggregates than they had historically" and the modeling sophistication is greater.

Another factor to be taken into consideration is Florida. "The state is now providing the bulk of the reinsurance in Florida," said Ms. Coogan-Pushner. "That is basically going to reduce reinsurers' premiums significantly," she said.

"There's a question in terms of what (the legislation) will do to the property market in Florida, and more broadly in the U.S, and whether or not that may impact pricing outside of Florida in casualty and other areas outside of property," said Damien Magarelli, a director with rating agency Standard & Poor's Corp. in New York.

Meanwhile, prices are softening, say observers.

"The January renewal cycle definitely showed signs of softening across most major lines of business," except for U.S. catastrophe-prone coastal areas, said John L. Ward, chief executive officer of Cincinnati-based Cincinnatus Partners L.L.C., an advisory firm specializing in the insurance industry.

But, he added, there are "not nearly the indications of softness that we're seeing in the primary market, so there'll be a bit of a disconnect between the reinsurance market and the primary market in the U.S., with the net pricing pressure on the primary carriers," he said.

"I think as we go through the year, looking at July renewals, we'll see more pressure" on rates, said Mr. Gallant. "Jan. 1 prices are down 5% on average. You had prices down 10% or so in casualty lines, but up modestly in the property area."

"But as we move towards midyear, I expect downward pressure across the board, so we could see sort of average prices down 5% to 10% by July 1," Mr. Gallant said.

In another indication of a softening market, John Laubach, a senior financial analyst with Oldwick, N.J.-based A.M. Best Co. Inc., said there has been some weakening in treaty terms and conditions, although "most of them are minor to moderate at this point."