Insurers could turn to catastrophe bonds if reinsurance rates rise significantly at January renewals

The subject of reinsurance rates and whether they will rise at the 1st January renewals has been a hot topic all year with many reinsurers expecting increases and many brokers attempting to get the best prices possible for their clients. Events during 2011 such as the New Zealand earthquakes, Japanese tsunami, U.S. tornadoes and recent risk model changes have all pointed to rising property catastrophe reinsurance rates, but by how much?

While reinsurers are clamouring for an increase in rates and many observers fully expect to see rate rises at the January renewals there is a danger that reinsurers could price themselves out of some significant accounts if rate increases are too steep. Some insurers are suggesting that catastrophe bonds could prove an alternative to paying inflated rates for some layers of their reinsurance cover.

We’ve spoken with a number of smaller primary and middle market U.S. property insurers who all expressed the same opinion, that capacity was most likely available through the capital markets should they need it. Many of these smaller residential property insurers have seen the successful private placement of the Oak Leaf Re cat bond earlier this year and are now weighing up whether a similar sized structure could be cost-effective for them. Rising reinsurance rates could be just the thing to trigger more of these types of deals.

Another group we’ve discussed this issue with are captive managers, many of whom are beginning to look more seriously at the capital markets as a source of reinsurance or risk transfer for some of the risks their captives hold. Price is a key factor for captive managers and again if reinsurance rates rise significantly they are likely to intensify their scrutiny of the capital markets options available to them.

Finally there are the larger U.S. property insurers. Rating agency Moody’s have published a brief update on some of the topics they saw discussed at the recent Monte Carlo Rendezvous event and one of those topics is reinsurance rate rises. Moody’s suggests that they expect to see P&C rate rises of high single-digits or low double-digits but say that it’s not clear why rates would increase by any more than that, especially for larger reinsurance customers. Additionally they say that the catastrophic losses experienced during the first half of the year have only eroded reinsurance capital by 3%, so they see no reason for large rate rises.

Most interestingly they suggest that large U.S. insurers, the likes of Travelers, The Hartford and Chubb, all have catastrophe bond programs that they can tap for additional protection should they feel the need. They point to the lessons learned post hurricane Irene as one factor which could drive these large insurers back to the cat bond market. However a much more persuasive reason for them to issue more cat bonds under their existing programs would be if reinsurance rates rose so much that cat bonds became a much more attractive and even cheaper option.

The lesson here for reinsurers isn’t to ‘beware what you wish for’, rather it is to approach rate rises sensibly by looking at all the factors which contribute to rising rates and never forget that your clients have other options at their disposal which are becoming more readily available and competitive.