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Aspen Opinion

Time for change

Brian Boornazian, James Few and Emil Issavi
29 December 2011

Brian Boornazian

Chairman, Aspen Re and President, Aspen Re America

Fundamental changes in the operating environment for reinsurers demand a higher price for the exposures they assume. Aspen Opinion talks to Aspen Re’s Brian Boornazian, James Few and Emil Issavi.

When we come to look back at 2011, the year is likely to be viewed as the turning point for the property and casualty (re)insurance markets. While this year’s natural catastrophe losses did not quite match the scale of Hurricanes Andrew or Katrina, various factors are combining to drive a steady firming of property casualty rates after a near-record year of natural catastrophe losses. This is likely to be sustained in 2012 and beyond.

Rates in some lines have already started to move upwards, and market expectations are that this trend needs to continue. A combination of factors – not only catastrophe losses, but also rock-bottom casualty rates and record-low interest rates – are leading reinsurers to reassess the exposures they take on their balance sheets.

Perfect storm brewing for 2012

2011 was a roller-coaster ride for the industry, with various costly disasters occurring around the world. Earthquakes in Japan and New Zealand, floods in Australia and Thailand, and tornados in the US were all surprisingly costly. But there were near-misses too, such as Hurricane Irene that threatened New York and the East Coast earthquake that shook Washington.

But the seemingly higher frequency and cost of catastrophes are not the only factors that should drive (re)insurers to seek substantial rate increases, says Brian Boornazian, Aspen Re's Chief Executive Officer.

“We are in the midst of a perfect storm, but some reinsurers and cedents are only now beginning to recognise just how bad the weather is,” he says. “A number of factors are now driving a change in market conditions. The market has experienced a period of historically high catastrophe losses and low casualty rates. The situation has been compounded by low investment returns, level of prior year reserve releases not likely to be sustainable in future years and changes to catastrophe models.”

This year is already the second most expensive ever for catastrophe losses, and may even end up being the most expensive. It also follows a costly 2010 for insurers – the fifth most expensive year on record for insured catastrophe losses.

“The recent high level of catastrophe activity, especially in 2011, has coincided with very low casualty rates,” says Brian. “Casualty rates are now at levels last seen in 1999, which is generally recognised as the bottom of the last soft market.”

Low investment returns call for underwriting response

Emil IssaviInvestment returns have historically been the key driver for (re)insurers’ profits but investment rates are now down 500 bps (basis points) since the low point in the cycle in 1999. A study earlier this year by rating agency A.M. Best showed that US domestic reinsurers would need to improve combined ratios by 7.3% for every 1% fall in investment yields in order to maintain current return on equity.

There is an urgent need for a dramatic change in the casualty (re)insurance markets, says Emil Issavi, Aspen Re’s Head of Casualty and Executive Vice President.

“There have been seven consecutive years of rate reduction since 2004. At the same time, investment yields are close to all-time lows and do not generate sufficient returns to support underwriting at the rates they once did,” he warns.

“Casualty underwriters need to be more realistic and realise that the low interest environment could exist for a relatively long time and that prior year reserve releases may not be sustainable in future years at the same levels. Their psychology needs to change, because they can’t keep pricing casualty business as before and still achieve the same levels of profitability.”

Positive signs, but more needed

According to Brian Boornazian, the Property & Casualty industry needs to address premium rates to compensate for the lower investment returns and higher catastrophe exposures. There are early signs of a change in the market, but much more is needed to react to the fundamental changes seen in 2011.

“We’ve started to see traction in the past three to six months with large US insurers reporting increases of 5% to 6%, while loss-affected reinsurance business has seen a variety of significant increases and there is no longer talk of rate reductions. But we’ve yet to see rate increases in non-loss affected reinsurance business, which are also necessary to get the market to where it needs to be,” he says.

Casualty prices are adjusting in areas where pricing is inadequate, but they have yet to harden, adds Emil Issavi. General rate increases across all lines are needed to account for the fundamental lack of bond yields, he says.

James FewUnderwriting returns for long-tail business do not make sense, says James Few, President of Aspen Re: “Casualty business is driven by premium rates and investment returns. If investment returns collapse, underwriting rates need to reflect that. But, so far, the industry has ignored this issue.”

There are signs that some US casualty writers are seeing some rate increases, says Emil Issavi. “But the proof of the pudding is in the eating and we will have to wait another quarter or two to see if the increases can be sustained. We are now at the cusp. Just one event – for example deterioration in prior year reserves – could turn 2% increases into rises of 10%.”

It is a positive sign that primary rates are showing signs of turning but, for James Few, more is needed: “Casualty rates are back to levels seen when the market last hit the bottom of the cycle, so a few single digits are not enough, in absolute terms, after years of reductions.”

At a tipping point

According to Brian Boornazian, there are already some positive signs of change for the January 1 reinsurance renewal: “We are at a tipping point. We’ve yet to see meaningful increases but we’re no longer seeing rate decreases going down. Barring a major catastrophe, we would expect to see gradual and continued firming of property and casualty rates in 2012 and beyond.

“A variety of contributing factors (high cat losses, low casualty rates, low yields, drying up of reserve releases and revised cat models) are now coming through to support a sustained market firming that will last longer than previous cycles,” he predicts.

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