The reinsurance sector's hopes of posting strong earnings in 2010 took a knock this week as two major European players reported slow January renewals, suggesting that companies will need to slash costs and claims this year to support profits.

Germany's Hannover Re (HNR1.XE) said Wednesday that rates for contracts renewed in January were flat to slightly lower than the year before, with the steepest fall registered in some property reinsurance markets--where they dropped about 5%--a reflection of globally weak housing markets.

Fellow German company Munich Re (MUV2.XE), one of the world's largest reinsurers, said Tuesday that average renewal rates declined by about 0.3% as demand from insurers weakened, prompting analysts to forecast that rates will continue to fall this year.

Reinsurers act as a backstop to the insurance industry, taking up the riskiest policies in exchange for a premium. The risk is backed by the reinsurer's capital. The bulk of the world's property-and-casualty contracts are fixed at the January renewals round.

Reinsurance prices usually follow a cycle. After a large and costly catastrophe, such as a hurricane, demand for reinsurance goes up because insurance companies have less capital spare to cover claims themselves. The absence of costly catastrophes, as in 2009, gives insurers the financial means to carry more risks on their own balance sheets, reducing demand for reinsurance and causing premium rates to drop.

Despite low claims last year, reinsurers had expected the economic slowdown and the impact on insurance companies' capital in the wake of the financial crisis would increase demand for reinsurance, helping to support rates.

But Munich Re said the market was now more difficult than in 2009 and that primary insurers' balance sheets had recovered "more quickly than expected."

"The renewals involved some tough negotiating," Munich Re management board member Torsten Jeworrek said.

Hannover Re, meanwhile, said that in the current market it expected only "modest premium growth for 2010," and that because of sluggish financial markets it cut its operating profit margin guidance for 2010 to above 10% from a previously forecast figure of above 12.5%.

Last week, Lord Peter Levene, chairman of insurance market Lloyd's of London, had warned that it will be difficult to increase rates this year because of a lack of huge disaster in 2009.

He also said business will be "though" because of the current financial market as bond yields are likely to remain low and as stock markets are expected to move sideways, making it difficult for reinsurers to make healthy investment gains.

Reinsurers predominantly invest their premium income in bond and stock markets.

Swiss Reinsurance Co (RUKN.VX) and France's Scor SE (SCR.FR) will publish January renewal figures by mid-February. Analysts expect an equally sluggish growth performance from them as both firms are likely to underwrite only profitable reinsurance contracts, forsaking growth for stable profits.

Industry executives who declined to be identified said they hoped growth would pick up before 2012, when new industry regulation is likely to force insurers to keep more capital on their balance sheets.

The stricter financial demands of the so-called Solvency II rules will leave insurers with less capital available to cover risks. Instead, many insurers will need to transfer some of their peak risks to reinsurers.

Reinsurers expect to tap further growth by taking on risks from private and government pension funds, which are increasingly pressured by the longevity of pensioners, who now live much longer than before.

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