The usual Baden scene is of executives with collars turned up against driving rain, criss crossing between the posh hotels where they meet to earnestly discuss the cathartic effect of the latest natural or financial disaster.

But this year it is different in lots of ways. The sun is shining for a start. Also, while the financial crisis hasn’t actually gone away, the markets are more settled than this time last year. Just as important, it has been a benign year so far in terms of catastrophe losses.

It is Autumn and there is still plenty of time for a windstorm in Europe – but for a lot of the reinsurers here it feels a little like Spring.

There are a number of reasons for that. One is that, having come out of the credit crunch relatively unscathed reinsurers have proved the resilience of their product to their clients, according to underwriter Sharon Gallagher of Kiln Reinsurance 510. “Reinsurance capacity is stable and that’s valued by clients. It is incredible in the circumstances just how stable reinsurance pricing is,” she said. 

Richard Chattock, active underwriter with Montpelier Syndicate 5151 agrees that there is increasing recognition of the value of secure reinsurance. “Everyone is aware that the capital markets could go bad again,” he said. 

Reinsurers are even optimistic about the possible effects on their business of Solvency II, the regulatory regime that will take effect in 2012. In his traditional breakfast press call in Baden-Baden, Munich Re director Ludger Arnoldussen said that Solvency II would lead to a renaissance for reinsurers.

Under the new Solvency II rules, recognition of reinsurance and its capital relief effect is no longer limited to 50% (as under Solvency 1) with unlimited cessions possible. “The value proposition of reinsurance companies is greatly improved as a result,” Arnoldussen said.

Reinsurance brokers in Baden-Baden have an extra spring in their step too. They point to a growing trend for cedants to spread their reinsurance shares a little more widely in order to reduce counterparty credit risk. Nick Frankland, chief executive for Guy Carpenter Europe said it makes sense for insurers to achieve a spread of reinsurance within a band of acceptable security: “It is better than having a concentration in that same band,” he said.

Lloyd’s franchise performance director Rolf Tolle, holding court from a comfy chair in the Brenners hotel, said he discerns a willingness among cedants to diversify their reinsurance panels. He believes that Lloyd’s will be a beneficiary of the trend: “We see the amount of business being offered to Lloyd’s is increasing,” he said. “We’re in a good position in terms of being able to offer syndication with good security.”

Of course, Baden-Baden is not completely changed in character and arguments about the necessary direction of the market still fill the air. Mr Tolle, who has been attending the meeting since the late Seventies, has witnessed the market’s ups and downs over the years.

This year is his last as a representative of Lloyd’s because he steps down at the end of the year, handing over to a new director of underwriting, Tom Bolt. “It is clear that an improvement in pricing, terms and conditions is needed in both the reinsurance and underlying insurance business. But I suspect the market will stay flat,” he predicts. “In a sense the market is a victim of its own success because capital has not been destroyed – it has been replenished.”

On the other hand, the market for all other sectors continued to be extremely competitive with rates trending down, ample capacity and the broadest terms and conditions seen in years, Aon says.

Most insureds should expect to see stable rates in the short term, brokers agree, while rates for financial institutions are expected to continue to increase.

Willis in London also says that the commercial sector continues to resist the sharp rate increases for D&O insurance seen in the financial institutions sector, with the average premium for commercial business falling 5% in the second quarter. In contrast, some financial institutions have seen “double digit” premium increases, in percentage terms.

Willis stresses that the 5% reduction is for commercial clients with strong risk profiles.

But even these buyers could soon be seeing prices trend up, both brokers warn. “The delicate balance between the forces holding D&O prices down and the need for rate increases could soon shift in the favour of underwriters,” said Michael D. Rice, national practice leader of Aon’s financial services group.

Commenting on the findings of the Willis survey, Julian Martin, executive director of Willis FINEX Global, warned, “Owing to the economic downturn, we are experiencing an increased level of scrutiny and underwriting analysis, meaning that is essential for renewal negotiations to begin early in order to deliver timely renewals.”

You have been warned.

Greater stability in the reinsurance market produced by signs of recovery in the financial markets, coupled with a lack of big underwriting losses in the first two quarters of 2009, compensated for reinsurers’ losses over the preceding 12 months.

In the property-intensive mid-year renewals, rate increases were moderate reflecting a lack of meaningful rate hardening in the primary market, Willis Re said. It pointed out that many primary insurers continue to face soft pricing, weaker demand and reduced investment yields while their prior-year reserve releases have largely run out.

Aon Benfield describes reinsurance markets as ‘firm but functional’. The broker’s renewal report stated that while the US reinsurance market for hurricane exposed programmes continued to harden, renewals of catastrophe exposed programmes outside of the US remained firm and were influenced by regional loss experience and reinsurer competition to participate in regional programmes.

Bryon Ehrhart, CEO of Aon Benfield Analytics, gave reinsurers a slap on the back: “Reinsurers have generally done a superior job of managing capital through these turbulent times and have continued to renew the core capacity required by our clients,” he said.

Peter Hearn, CEO of Willis Re said that the reinsurance industry is providing sufficient capacity at acceptable prices to its client base this year. “Nine months ago, this outcome was very much in doubt,” he said. “Now, this relative stability will largely hinge on whether positive pricing trends emerge in the primary insurance markets and the level of major catastrophe and financial loss activity.”

Guy Carpenter, the reinsurance broking unit of Marsh concurred, saying that stabilisation in the global financial markets has contributed to the steadying of reinsurance rates, ‘with capital deterioration slowing markedly from the rapid pace witnessed in 2008’. As a result, reinsurance supply remains generally adequate to meet demand.

The key findings of the Willis report (pdf) are:

• Rate increases in the region of 10 to 15% were achieved in capital-intensive classes such as peak zone US catastrophe.
• Merger and acquisition activity has started to pick up, as those with stronger balance sheets seek to adjust their portfolio mix and/or acquire platforms in markets previously difficult to access.
• There is a continuing disconnect between buyers and sellers in the marine sector over the pricing of Gulf of Mexico energy-exposed business, with buyers looking to co-insurance and/or higher retentions in response to high relative prices.
• Rates outside US peak catastrophe zones have struggled to show much real increase as diversification of exposure remains a pricing driver.

The key findings of the Aon Benfield report (pdf) are:

• In the US, predicted hardening caused many programmes to be marketed and placed prior to July 1. Pricing changed at a level consistent with 1 June renewals—increasing 10 to 15%.
• In the Asian market, excluding China and Japan, there were no major changes in coverage, exclusions and conditions in property catastrophe lines. 
• In the UK, rate increases of up to five % were recorded in property catastrophe lines.
• In Latin America, property excess of loss prices rose by up to 5%, with broadly stable terms and conditions and higher levels of retention in certain programmes.
• In Australia, property catastrophe pricing increased by 10 to 15 % overall, and by 5 to 10% on loss-free layers, as a result of large losses arising from the Queensland storms in 2008 and the Victoria bushfires earlier this year.

The key findings of the Guy Carpenter report (pdf) are:

• In the US firm order terms (FOTs) for higher layers grew between 11 % and 14 % relative to 1 July 2008 FOTs, while slightly larger increases—14 to 16%—were realised at lower layers.
• In Latin America preliminary data varied by country, but upward pressure on pricing was offset by supply and local market competition, which keep reinsurance rate increases contained.
• The 1 July 2009 marine reinsurance renewal remained consistent with the 1 January 2009 renewal, with rates increasing by 5 to 10% for XOL programs, based on loss history and catastrophe exposure.
• Capacity was limited for offshore energy programmes, for Gulf of Mexico windstorm in particular. As pricing and attachment levels increased, terms and conditions also tightened. A number of insureds chose to self-insure Gulf of Mexico assets, leading to a dramatic drop in aggregate risk limits.

Links

• Aon Benfield
• Guy Carpenter
• Willis

• I will instruct my underwriters to increase premium rates
• I will make sure my company achieves a technical profit across the board
• I will try to invest risk free
• I will initiate a root-and-branch programme of enterprise risk management, investing in whatever systems and people are necessary to make it work.

OK, I made that last one up.

But the industry is certainly going to press for rate increases come the January 1 renewal. It doesn’t have an option.

The reasons for such resolve are clear. Insurers and reinsurers have so far proved resilient to the problems besetting other financial institutions. But they need to be very sure footed if they are going to stay resilient over the medium to long term.

They’re not in as bad shape as banks, but insurers and reinsurers are still looking at depleted capital bases and minimal investment yields in the future. Their financial flexibility is constrained and no-one is sure how long this three dimensional crisis will last. An increase in claims activity caused by recession, a credit crunch with legs and a stock market correction all happening simultaneously? Not even the most seasoned industry bosses have seen that before.

In a presentation in London earlier this month, Swiss Re’s chief US economist Kurt Karl said if there is one thing he is certain about it’s this: the uncertainty will continue.

At least let’s be grateful that we are not in the banking business was the message from Karl and his Swiss Re counterpart, Thomas Hess. Insurance is fundamentally different to banking: you can’t have a run on an insurance company because payouts are not triggered by policyholders’ will; insurance hazards are uncorrelated and there is no contagion between insurers; and insurers are not exposed to short term fluctuations in asset values because they usually hold them to maturity.

Mr Hess acknowledged that the industry’s double whammy of reduced investment yield and hurricane-related underwriting losses had eaten into the industry’s solvency ratio. But he pointed out that it is still 20% better than the low figure recorded in 2002. “Insurers and reinsurers coped with that [ratio] in 2002 so that cushion still exists,” he said, before adding. “But it all depends on what happens ahead.”

Rating agency Standard & Poor’s agrees that reinsurers have sufficient excess capital available to absorb the shocks of 2008 (including windstorm losses), but its credit analysts point out that the cushion has lost much of its stuffing. According to their analysis, the combination of hurricanes Gustav and Ike and the impact of investment losses for the first nine months of 2008, adds up to around $22bn of capital erosion for nine of the largest global reinsurers.

S&P says that this ‘AAA stress’ has effectively wiped out 85% of the excess capital held by that same group of reinsurers, on the basis that they had a total of $25.4bn at the beginning of the year.

If that doesn’t concentrate everybody’s minds on underwriting for a profit, I don’t know what will. How about the possibility of a major nat cat event blasting up the US east coast sometime next year? Enter Aon Benfield’s climate Cassandras.

The Aon Benfield UCL Hazard Research Centre boffins are predicting an active Atlantic hurricane season in 2009. In their news release they ask readers to note that their long range forecasts do not have a great record. But, based on current and projected climate signals, US landfalling hurricane activity will be 35% above the 1950-2008 norm they reckon.

So volatile weather and an inclement investment climate: uncertainties persist on either side of the balance sheet. That’s not good news for an industry sitting uncomfortably on a rather thin cushion. If the wind does blow, capital markets investors willing to help reload the industry will be in short supply, unlike previous years.

(Re)insurance industry CEOs are not well known for their resolve. This time it is different: they know they need to protect their capital position and they know how to do it.

Alternating between the grand hotels that stand along the riverbank—Badischerhof, Europaischerhof and the Brenners—delegates’ minds are filled with renewal rates, terms and conditions, solvency and profitability.

“I’ve been coming here for 15 years and I have never known a renewal like this one,” a veteran broker told me.

What’s different is that life has suddenly become very complicated. Like the weather, the business climate has become unpredictable and impossible to call. It has changed, but no-one is really sure what is going to happen next.

No doubt some people are missing the familiarity of the underwriting cycle: up or down, at least people knew where they stood. At Baden-Baden this year there is the unreal feeling that anything could happen.

In previous years, if there had been a storm like Hurricane Ike in the run up to renewals, everyone knew what to expect. Capital would be depleted, the market would harden and then later, new capital would come in to take advantage of it. This year, it’s not so simple. There are three elephants in the underwriting room: capital market meltdown, falling share prices and global economic recession.

Primary insurers who want to maintain their current business model (ie stay in business) are suddenly more dependent on reinsurance than they have been for a long time. It is virtually the only form of capital relief left open to them given the state of the markets. They want to retain less risk, they want to buy more reinsurance.

But reinsurers live in the same world. They are less exposed to the markets, but they just got smaller as well. As well as taking a hit on the asset side of their balance sheet, they’re finding (to their astonishment in some cases) that losses from Ike just keep on coming.

Surely that means that reinsurance prices can be jacked up, revealing to reinsurers at least a silver lining behind the clouds over Baden-Baden? Not so, apparently. While some reinsurers are predicting big rate increases (notably Munich Re which issued a press statement on Monday saying it expected a double-digit hike) others are less bullish.

Lloyd’s own Rolf Tolle, speaking at the Baden-Baden symposium, said he thought it was too early to call the bottom of the market. He said there is a justifiable fear among reinsurers that if they increase their prices they will lose the business.

At the same event, William Hawkins, the outspoken insurance research director at Keefe, Bruyette & Woods, pointed out that unlike previous post hurricane scenarios reinsurers have not actually lost a huge chunk of capital.

On the contrary, as other industry commentators pointed out, reinsurers were more or less prepared for Ike and Gustav having learned their lessons well. Now they are more likely to be hoarding capital because they don’t know what is going to happen next to them, nor how long the current turmoil in the financial markets will last. By keeping capital levels up, that may contribute to keeping the market soft going into next year

It is all very confusing. But at least it is keeping everyone’s mind off the rotten weather.

It must be a strange sight for any unsuspecting “civilian” arriving in the pretty German spa town during the last week of October. The sight of hundreds of men (and some women) in dark business suits crisscrossing the town, clutching their bulging briefcases, seems at odds with the otherwise sleepy autumnal scene.

But these people are on a mission. With the January 1 reinsurance renewal looming large on the horizon, buyers, brokers and reinsurance underwriters are starting to negotiate their deals.

It’s nice to imagine these discussions taking place in the relaxing, hot spa baths that the town is renowned for. The reality, however, is a scene of busy executives sweating contract details in overcrowded salons and hospitality suites around the town’s many plush hotels.

What are the big renewal related issues that will exercise people’s minds in Baden-Baden this year? Seymour Matthews, managing director of reinsurance at Lloyd’s broker Cooper Gay, expects some interesting discussions around reinsurance pricing this year, with reinsurers attempting to get into the driving seat.

“I believe reinsurers will be stressing the need for them to make underwriting profits in the current investment climate,” he says. “If reinsurers show a united front this could be a real turning point.”

Mr Matthews says that unexpectedly high losses from Hurricanes Ike and Gustav will also contribute to increases in reinsurance rates: “Cat losses for 2008 are considerably higher than the modeling agencies predicted.”

“The question European primary insurers will ask is whether they should be on the hook for US losses,” he says. “My personal feeling is that the days of the many paying for the few are over.”

Mr Matthews fears that the complex dynamics at play in the run up to this year’s renewals could slow things down.

“I worry that people will still be talking about all this in a month’s time and that the renewals will be very late again,” he told lloyds.com. “Cedants who are not prepared and leave decision making too late could be in for problems. Getting good advice early from their broker is key.”

Sharon Gallagher, underwriter at Lloyd’s insurer Kiln and a Baden-Baden veteran, agrees that reinsurance pricing will be the main topic on the agenda especially in light of recent events.

“Reinsurers are effectively loaning insurers their capital—in the current environment that is an expensive thing to do and with investment returns reducing, pricing cannot reduce, even for cedants without losses to their programmes,” she says.

“Although 2007 results were profitable, many of them were propped up by significant old year reserve releases and 2008 has seen its fair share of losses, whether large risk XL losses, Central European wind and hail losses, mid-West floods or the recent hurricanes [Ike and Gustav],” Ms Gallagher explains.

Ms Gallagher says that recent events emphasise the need for good risk management by reinsurers and insurers alike. “Whilst the reinsurance industry has made huge strides in recent years with cat modelling and, at Lloyd’s, with the Realistic Disaster Scenario returns, we cannot be complacent,” she warns. “As recent events in the banking industry have shown, models are only a guide and are no substitute for understanding the underlying exposure of a portfolio.” 

For their part, in the current climate, cedants need to factor in the possibility that their reinsurers might not be willing nor able to pay up when the large loss happens. “Regulators’ security rating requirements can push cedants towards concentrations of cessions with a handful of reinsurers when the whole basis of our industry relies on spread of risk,” she says. “We must ensure that we do not simply become slaves to ratings but that the benefit of diversification is given its proper place.”

NOTE: Baden-Baden was officially given its double barreled name status in 1931 and derives from “Baden in the state of Baden” – as distinct from other Badens in other German states.