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Chapter 9 Reinsurance market 9/23

Table 9.4: Managing the cycle
There is a cost to capital and the temptation to use it in unsustainable ways should be
Using capital efficiently
avoided. If rates are poor, participations may be scaled back. Alternatively,
participations may be withdrawn and the capital steered to other more attractive lines of
business (or elsewhere) where the rates are better and a return is more likely, or
returned to shareholders or from wherever it came.
The redeployment of capital in this way demands a highly flexible and ruthless approach
to underwriting which can lead to problems, not least when the market has corrected
itself and rates improve sufficiently to make it an attractive underwriting prospect again
and reinsurers seek to re-enter that market.
Typically, in such circumstances, there is a natural reluctance on the part of the
reinsured to allow a reinsurer back onto its programme, notwithstanding, for example, a
superior claims-paying ability over those on its current panel. To many, trust and
credibility has been lost. Indeed, many reinsureds and reinsurers continue to subscribe
to the traditional view that reinsurance represents a long-term partnership, albeit
reconsidered on an annual basis.

Be aware
The Performance Directorate on behalf of the Franchise Board is responsible for setting risk management and
profitability targets across the Lloyd’s market. It lays down guidelines for all syndicates and operates a business
planning and monitoring process to safeguard high standards of underwriting and risk management, thereby
improving sustainable profitability and enhancing the financial strength of the market.

Question 9.7
Why might the sacrifice of business have an adverse effect on the reinsurer’s ‘expense ratio’?

D4 Market capacity
A hard market attracts new entrants, as was evidenced by the new reinsurance capacity that was Reference copy for CII Face to Face Training
A hard market
established after 9/11. The majority of this new capital was located in Bermuda, in no small part due to attracts new entrants
its favourable incorporation and taxation regime.
Following the spate of hurricanes in the USA in 2004 and 2005, it is estimated that over US$30 billion in
new reinsurance capital entered the market in late 2005 and throughout 2006.

Be aware
Although there has been a huge increase in available reinsurance capacity since 2002 in the form of ‘start up’
companies, recapitalisations, catastrophe bonds and ‘sidecars’, it has also been estimated that some US$100 billion
capacity had withdrawn from the worldwide reinsurance market, some of it directly as a result of losses incurred
in 9/11.

Indeed, many insurance and reinsurance companies, such as Swiss Re, suffered a downgrading of their
security in the aftermath of 9/11. It is not unusual for insurance companies to request that reinsurance
capacity (and sometimes classes of business, especially those concerned with liability or casualty
accounts) is geared directly to the financial strength rating of a reinsurer – perhaps 15% for AAA
security, 10% for AA security and 5% for A, and so on.
Nevertheless, even allowing for insolvencies occurring as a result of a succession of poor annual results Chapter
that collectively aggregated from the late 1990s onwards, there were relatively few total withdrawals
from the market despite the severe incidence of losses during 2004 and 2005. 9

Reinforce
To summarise, market capacity is high during a soft market and low during a hard market. A hard market attracts
new entrants while a soft market discourages them.