Reinsurers and primary insurers have once again conjoined for their key annual interface, writes Kevin Godier

Like familiar marriage partners that overhaul their vows every 12 months, the two sides have been renegotiating capacity and rates during the traditional late autumn treaty renewal period – but against a far tighter underwriting landscape where significant post sub-prime credit losses in Europe and the US have turned insurers’ low loss ratios of recent years on their heads.

“Debtor companies are failing at alarming rates in all countries although most particularly in the US, UK, Ireland, Spain and Italy. As a result, rising loss ratios in the trade credit field have hardened noticeably those insurance and reinsurance markets” stresses John Orchard, managing director, credit, bond and political risk at Guy Carpenter, a key reinsurance brokerage in the discussions. On the trade credit side, which accounts for roughly as much reinsurance as surety and political risk insurance (PRI) combined, “the ‘Big Three’ – Atradius, Coface and Euler Hermes – are now looking at loss ratios pitched between the mid-60s and mid-80s,” he says.

“The same holds true for most of the next tranche, by volume, of trade credit insurers, such as AIG and QBE – although the structured trade credit and political risk insurance business is seeing very different, profitable, results,” adds Orchard.

The big picture is that “primary trade credit and bond insurers everywhere are reining in and de-risking as fast as they can from the sectors and companies with whom they are less than comfortable. Despite the unprecedented climb in demand for their cover and against a background where reinsurers are more particular where they allocate their capital – all of which is exerting further pressure on primary insurers to increase their rates”.

At Ace Global Markets, which had concluded its treaty renewal by early December, Julian Edwards, head of political risk & credit, affirms “a very tight market” for reinsurance. “We buy mainly quota share reinsurance”, says Edwards, referring to non-cancellable, pro rata reinsurance, adding that the pricing for excess of loss reinsurance – which is used heavily by the Big Three to protect against net losses on their retained accounts – “has gone up significantly due to risk reasons and the basic cost of capital.”

Edwards underscored that: “the psyche of reinsurers at the moment needs to be appreciated,” citing the enormous property losses resulting from Hurricane Ike and other flood-related losses, plus major hits on investment income as a result of financial market turmoil. “Availability of reinsurance capital has tightened up considerably, at a time when we are facing severe conditions in the credit and PRI markets,” he adds.

He continues: “In managing this renewal process, I believe reinsurers are making a large distinction between insurers that they believe are well equipped to see them through the next two years and ultimately take advantage of the future opportunities that will come out of this and the more marginal players who lack experience, resource and corporate commitment to the product.”

A “hardening of market conditions” in its credit and PRI business is also signalled by Dan Riordan, president of Zurich’s North America surety, credit and political risk division. “Reinsurers are active and staying active in our lines – where demand is so high that we are planning a capacity increase in 2009 – but they are looking harder at how they apply their capital,” he says.

“The soft market for credit insurance really finished in mid-2007, when the problems started,” underlines Elmar Schieder, head of credit department at Munich Re, whose premium volume of around €600mn in 2008 was worth around 10% of the overall trade credit, surety and political risk reinsurance market. “From 2003 to 2006 the clients’ results were very good, with combined ratios coming in at between 70% and 83%.”

For reinsurers, the ongoing crisis “offers a lot of opportunities,” says Schieder, highlighting that, “in the good years, the Big Three increased the business that they retained quite considerably, and all insurers that had enough capital would just buy excess of loss policies.” Now, he observes, “we see insurance companies looking to decrease their retention and cede more back to their reinsurers.”

Deep partnership

The inevitable waxing and waning of the primary insurers’ demand for reinsurance across the credit cycles necessitates that they strike up and maintain strong relationships. “When you choose a reinsurer, you want to make sure that you have partners that understand that this is a long-term commitment,” emphasises Riordan.  “Reinsurers are in effect your shareholders, and we treat them like shareholders – we count on them to help us through thick and thin,” he says.

Riordan suggests that major European reinsurers – which include names such as Swiss Re, Hannover Re, Munich Rea and Allianz – have evolved their predominant focus upon short-term credit insurance markets into a “greater interest in supporting medium-to long-term players like Zurich, who have slotted into the space where the public players were before”. He comments: “There has been a sea change there, with the recognition that the private players provide a good business line that is written well.”

This point was vividly illustrated in QBE’s November 2008 acquisition of the Exporters Insurance Company brand and underwriting team. At a point in the underwriting cycle when aggregates were pressured, QBE was able to double the previous per obligor limits under the reinsurance programme to US$50mn.

The heaviest reliance on reinsurance nonetheless still flows from the ‘Big Three’ credit insurers, none of which were particularly forthcoming about their reinsurance practices. “Reinsurance issues are an internal matter for us,” explains Raphaële Hamel, group communications director at Euler Hermes.

However Robert Nijhout, executive director at the credit insurers’ umbrella body, the International Credit Insurance and Surety Association (ICISA), highlights that, “there continues to be a long-term commitment to the sector from the leading reinsurers”. In terms of reinsurance market trends, he notes the common theme that “rates are rising while retention rates on the primary side show a downward trend”.

As with the ‘Big Three’, one of the leading reinsurers, Swiss Re, also provided no comment on the market. Swiss Re has been a reinsurance pioneer, with initiatives such as a January 2006 credit risk transfer, which offloaded some €252mn in future balance sheet risk exposure via a credit reinsurance securitisation. However Swiss Re has been forced to contend with a major derivatives trading loss in its investment operations. Indeed, “potential support from all reinsurers this year has been tempered by the extent to which their capital base may have been affected by events in global markets,” points out Ted Watson, of reinsurance brokers Watson Robinson & Associates. “Less capital means less spare capacity,” he says.

Capacity is tight but not impossible, according to Keith Thomas, divisional director, trade credit, surety and political risks practice at HSBC Insurance Brokers. “Reinsurers were approached in 2008 to increase the per country limits on a selective basis to allow the primary insurers more capacity to accept new business in high demand countries such as Turkey, Russia, Ukraine and others. Evidently certain reinsurers refused requests for Turkey, presumably due to a wariness that they had high accumulations from all their cedants, but there was a window when we found pockets of primary capacity,” he says.

Good business

Despite the carnage in some credit and bond markets – Spain especially, where some insurers are facing loss ratios of over 100% – the credit/surety/PRI underwriting class “is clearly a profitable line over the cycle”, observes Jan Mueller, associate director, credit, surety and political risk at Hannover Re, which has been writing the business for nearly 20 years.

“From 2003 to today, the results from the three lines have been very good, and only in 2008 have now shown some level of deterioration as a consequence of the tightening credit climate,” says Mueller, citing around €370mn in premium received annually by Hannover Re. “If we exclude this renewal, there has been an over-supply of reinsurance capacity in the last three years, due to the extremely low loss ratios,” he adds.

“Over the last 10 years the arena has transformed – primary underwriters are now far more analytical, and their decision-making far more disciplined,” notes Watson.

“This is my 12th treaty now,” highlights Riordan. “Over the years, I’ve seen reinsurers investing increasingly in specialist PRI and credit personnel and expertise, so that they understand the product lines and risk assessment processes better. As people continue to join from the primary and broking markets to add to this expertise, the better internal communication in place means that the dangers of over-reacting to headline risks have decreased, and the long-term commitment to the business has increased.”

A major clue to the viability of the primary business, says Schieder, is the increasing presence of significant multi-line insurers such as MAPFRE, QBE, Zurich and AIG. “Multi-liners tend to pay more attention to those lines of business, which are very profitable over a long period. This should make people ask again about whether the volatility of the business class is as high as some might think – we believe it’s a relatively stable and manageable business,” he comments.
Another positive is the recent entrance into the reinsurance market of Aspen Re and Liberty Re, notes Orchard. Riordan adds that: “there has been more interest among Bermudian reinsurance players in this class for the last five years, particularly the specialists in catastrophe risk.”

One major change in the market structure, adds Schieder, is that in 2002-03, the majority of reinsurance business was written for what were then the Big Four or Five players. “Today, about 50% of our business is from developing markets such as Brazil and China, where the biggest companies have increased their premium volume considerably over the last few years.”

Renewals challenge

Schieder points out: “this means it now could become difficult if some bigger clients want to increase their reinsured capacity again, be it because they apply a different model to calculate or the supervisory authorities request different capital ratios.” He adds that “our capacity is limited, and we will always allocate it to the business which offers the best chance of a good return”.

Mueller notes that “some clients are adjusting their appetite, not drastically, but to the extent that any permanent retention of the business is over”, stressing that the end-2008 renewals discussions have taken longer due to the market hardening.

“In all markets clients have taken drastic measures, partly strong rate increases and, on the risk side, with an appropriate consolidation of their books. The hardening of credit insurance rates and conditions started in the US, Spain and Italy and is now coming to a certain extent to countries such as the UK, France and Germany,” he comments.

In the surety business, which accounts for about 40% of Hannover Re’s credit, surety and PRI reinsurance income book, the construction downturn in some countries in response to economic slowdown is a fact of life. However, “our business is carefully underwritten and well spread over different regions worldwide,” adds Mueller. “In the US we are not exposed to frequency risk as we offer the surety product only on an excess of loss basis.”

Although the PRI market is not directly correlated to cyclical movements with credit and surety, generally increasing protection demand hikes up risk prices on the primary as well as reinsurance side, Mueller observes.

However Corina Muller Monaghan, New York-based vice president of Aon’s trade credit and political risk practice, contends that “in theory, the rate for non-payment insurance for transactions with government buyers should not increase substantially”. Her view is that “government buyers do not appear to have defaulted on their obligations at the same rate as their private sector peers, and so medium-term government obligations should not be punished by losses realised in the private market”.

The likely reality, says Monaghan, is that treaty underwriters will combine the commercial and political risk losses of 2008 on a per country basis, leading to capacity issues in many countries. “A shortage of capacity in any given country, due to defaults by the private sector, will inevitably cause increased rates for ‘pure’ political risk transactions,” she forecasts.

Market outlook

Looking further ahead, future reinsurance capacity is a concern, acknowledges Nijhout. “We expect that a number of reinsurance players that have entered the credit or surety market over the past years will retreat if they have not done so already.”

“Classically, as times become more difficult, you find that the flight to quality starts again,” indicates Mueller. “Newcomers that get their feet in the door often look to get out before the portfolio deteriorates.”

How will the market pan out in 2009 and beyond? “2009 is highly unpredictable, but the opinion of Munich Re and its clients is quite optimistic,” says Schieder.

“2009-10 could still be problematic, but 2011 should be a reasonably profitable year, if we can judge by past downturns, which always last between two and four years.”

Mueller concludes that: “in 2009 it is hard to predict anything, although under normal circumstances, there should be an improvement in the loss situation during 2010”.