Despite the financial and economic turmoil of the last several years – both nationally and globally – the insurance market has remained remarkably stable.  There have been surprisingly few insurance company failures, and premiums have remained at worst flat, and in most cases have seen year on year decreases.

As explained in a prior article I wrote, the soft market was largely the result of long term excess capacity in the market place – meaning insurers had to compete hard against each other to get clients’ business.  Another factor was the reinsurance market – the mechanism by which insurance companies insure the risks they take on and spread risk to a much wider pool.  For a number of years reinsurers have enjoyed relatively easy years, and have seen relatively few major catastrophic losses.

However, 2011 was a particularly bad year, especially for property losses.  One measure of insurance and reinsurance companies’ business sustainability is known as the Combined Ratio.  In simple terms, this is the ratio of money paid out (losses, commissions, underwriting expenses, etc.) to money taken in (premiums).  Insurance companies try to keep this below 100% – meaning they pay out less than they take in.  In practice, they also earn investment income, which means that even with a combined ratio a few points in excess of 100% they are not necessarily losing money.  In 2009, a basket of the largest global reinsurers had an overall weighted combined ratio of 93.5%.  In 2010, it was 95.4%.  These numbers meant reinsurers were, as a group, very profitable.  However, in 2011 that number shot up to 107.2%.  Several reinsurers had a combined ratio in the 115 – 120% range, and two were above 130%.

There were a number of reasons for this.  It is important though to realize that the reinsurance business is a much more global one than the primary insurance market.  In 2011, the US suffered a very bad early hurricane season, with insured losses estimated at $13 billion.  The New Zealand earthquake is estimated to cost reinsurers around $11 billion while the Japan earthquake and tsunami are likely to end up costing reinsurers approximately $30 billion.  Late in the year were the Thailand flood events, estimated at $15 billion.  All in all, global insured catastrophic losses in 2011 are estimated at $100 billion – more than twice the losses in 2010.  In fact, 2011 was the second worst year for insured cat losses in history. 

Compounding these losses was the fact that investment income is also at historically low rates, and has been for several years now.  As noted earlier, insurers and reinsurers use investment income to cover underwriting and operating losses as part of their business plan.

While reinsurers had, generally speaking, plenty of cash in hand and could withstand a bad year, the outlook is unfortunately not good.  The third prong of this poor outlook is the European crisis, which shows no signs of abating.  The longer range financial forecasts for Europe are almost universally bleak, and the European Debt Crisis could impact reinsurance in the US in several ways.  First, there is the heightened credit risk associated with possible fiscal downgrades of European reinsurers.  There is also a significant risk of increased regulatory and rating agency involvement – which will translate to higher transactional costs and tighter regulation on investments – lowering returns even further.  The ongoing severe recession in Europe is also resulting in reduced demand and thus lower premiums, which could result in lower capacity as well.  In other words, a downwards spiral.  These European woes will almost certainly affect the US market for reinsurance, and that is likely to adversely affect the primary insurance market as insurers find reinsurance more costly and more difficult to obtain.

Medium term projections predict losses from catastrophic weather-related events to continue to increase as a result of climate change.  Reinsurers, wary of another bad year, will therefore limit exposures and increase premiums – particularly in the large scale property insurance market. 

Buyers of insurance, particularly those with large property risks in areas susceptible to weather-related exposures, will find the prices increasing and availability tightening over the next couple of years.  Reinsurance rates are forecast to increase anything up to 15% even for such insureds who have not had large losses.  Reinsurance on policies for insureds who have suffered losses could go up even more.  Those increases won’t translate directly to similar increases in primary insurance, particularly for insureds with smaller exposures, since they will be spread out across the markets and the effect will be diluted.  But overall, prices of property insurance in particular are starting to drift higher, especially for large risks.  And that trend is likely to continue.

Pressures on pricing are lower in the casualty (liability) market (including E&O and D&O), with the sluggish world economy continuing to hold back rate increases.  Carriers continue to compete against each other for business, but are paying more attention to risk management and underwriting concerns.  Reinsurance rates should not increase much, if at all, and this will translate to primary premiums staying pretty much flat.

In conclusion, insurance buyers and risk managers should not expect much change this year, unless they have large property risks in geographic locations prone to potentially catastrophic weather-related events.  But especially if the reinsurers have another bad year, the low premium party may be coming to an end.