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9/20 M97/February 2018 Reinsurance

When hard market conditions prevail, capacity (or capital) reduces as reinsurers withdraw or reduce their
acceptances, reinsurance terms harden and the economic laws of supply and demand apply, with costs
being driven up. The result is that the buyer may have to accept tougher conditions, in the form of higher
retentions or lower commissions or more restrictive terms and conditions of coverage (for example,
exclusions), than they would have preferred.
Finally, the wider investment and tax regime environment can be relevant in the decision to buy
The wider investment
and tax regime reinsurance. When stock markets are high, buyers may have a choice of investing in equities, for
environment can be example, which are likely to provide a profitable and quick return, as opposed to purchasing reinsurance
relevant in the
decision to buy which they do not really need, provided they have the strength to stand a limited number of
reinsurance unexpectedly large losses.
In profitable years, the purchase of reinsurance can reduce the tax liability of insurers as this is
assessed on the net rather than the gross underwriting result and can offset the tax on interest or profits
on equities.

D1 Hard reinsurance markets
Hard reinsurance markets tend to follow an abnormally large loss, and particularly a large natural perils
event loss, such as an earthquake, a severe windstorm and sometimes an extensive flood, that affects a
sizeable developed market, such as the southeastern USA where losses are measured in billions of
dollars.
Example 9.3
Between August and September 2004 a series of four hurricanes – Charley, Frances, Ivan and Jeanne – hit the
Caribbean, including Florida and Alabama, occurring in a relatively restricted region. The reinsurance market reacted
to safeguard its interests at the next renewal of such business.

If similarly large natural perils event losses occur simultaneously in different parts of the world, such as
storms and floods in New South Wales, Australia, in June 2007 while severe windstorms rage in western
Europe, then this further strengthens the resolve of the worldwide reinsurance market. Many ‘first tier’
reinsurers purchase retrocession coverage sufficient to cover two separate events, but the sheer number Reference copy for CII Face to Face Training
of large hurricanes experienced in 2005 meant that some reinsurers simply ran out of coverage for the
third and fourth hurricanes that had devastated their inwards book of business.
In extreme circumstances, some reinsurance capacity is totally withdrawn from the market, some is
realigned into different layers of cover or different geographical areas, leaving those reinsurers who
remain active to negotiate the best renewal terms, coverage and conditions that they can. Despite their
financial strength, many reinsurers had to request additional capital at the end of 2005 to maintain their
solvency margins and to remain in business.
As we have already suggested, the retrocession market also plays an important role in guiding the ‘first
Retrocession market
also plays an tier’ reinsurance market. Restrictions imposed by a retrocessionaire can limit the coverage that
important role in a reinsurer provides to its reinsured, unless the reinsurer is prepared to accept any difference in
guiding the first tier
reinsurance market exposure for its net account. For instance, many retrocessionaires impose restrictions on the number of
reinstatements – say the original loss plus one. The result of this is that reinsurers of that original
insurance business sometimes face the dilemma of whether they should allow reinstatement of a loss in
the same event. The practice differs between markets – it is quite common to restrict reinstatement in
the same event in the North American market, but less common elsewhere.
9 It is also rare that one single risk loss has a dramatic effect on hardening market coverage, terms,
Chapter single risk, and it would usually be restricted to a relatively narrow range of market participants.
conditions, warranties and exclusions, as reinsurance practice considers that a single risk is just that, a

Be aware
A marine, energy or aviation loss would not necessarily affect the market perceptions of the industrial or commercial
fire market.

Nevertheless, there are exceptions where an incident occurs of such magnitude that its effects
9/11 affected all
insurance and reverberate around all insurance and reinsurance markets, the obvious one being 9/11. This event gave
reinsurance markets rise to a dramatic hardening of both insurance and reinsurance markets worldwide and is one that is
perhaps unlikely to be repeated in the foreseeable future.