Higher reinsurance costs likely to reaccelerate primary rate increases

The hardening reinsurance market at 1 January could well “reaccelerate” price increases for commercial property and specialty insurance buyers, market analysts have told Commercial Risk. Reinsurance pricing has lagged primary markets in recent years, while relaxed coverage terms have seen reinsurers pick up the tab for a number of costly frequency events, such as US winter storms and record-breaking floods in Europe. Following a turbulent reinsurance renewal in January, however, this favourable situation for insurers now appears to be changing, with important implications for primary policyholders. Following the 1 January renewal, many insurers are now paying more for less reinsurance protection. Reinsurance rates in Europe and North America have increased by double digits while deductibles and attachments points are up substantially. Reinsurers have also narrowed coverage in a bid to reduce their exposure to costly frequency weather events, like convective storms, floods and hail storms, as well as non-catastrophe perils such as war, riots and civil commotion. The end of the year saw a marked change in the cost and breadth of reinsurance protection purchased by most commercial and specialty insurers, said Mike Van Slooten, head of business intelligence for reinsurance solutions at Aon. “Reinsurance is moving back towards being a capital protection product, rather than an earnings protection product,” he told Commercial Risk. A number of insurers were able to buy the reinsurance they needed at 1 January to cover off regulatory and ratings requirements, but it was not necessarily the protection they wanted, explained Van Slooten. “There has been a significant shift in catastrophe risk back to the primary market. Reinsurers have pushed up prices significantly, and required primary insurers to retain more risk, and at the same time in many cases tightened coverage,” he said. “Exposures have gone up with inflation. Insurers were wanting to buy additional limit but at the end of the day many did not because it was too expensive. There may be pent up demand [for reinsurance] that could re-emerge in the next three months,” added Van Slooten. John Andre, managing director at AM Best, said primary insurers, in particular those with loss affected business, will be paying more for reinsurance coverage going forward. “Even many with strong performance will see rate increases. In order to control their reinsurance spend, primary companies may now be attaching higher or sharing in some upper layers or just buying less cover,” he said. The changes in reinsurance market conditions at 1 January will filter down to commercial property insurance policyholders, explained Van Slooten. But he said the impact will vary by line of business and geography. Property catastrophe and war-exposed specialty lines are most affected, with larger insurers typically better positioned to absorb higher net retentions and earnings volatility than smaller players, he noted. “There is now an expectation that higher reinsurance costs and additional retained volatility will be dealt with through higher primary pricing. Broadly speaking, primary pricing has been trending up for a while, although the steam was coming out of it, and increases were slowing down. There is a suggestion now that [changes in reinsurance market conditions] will cause a reacceleration,” he said. There could also be a knock-on effect from reinsurers retrenchment from catastrophe risk, according to Van Slooten. “In the same way that reinsurers haven’t been able to buy as much retro cover as they want, there are primary insurers that have not been able to buy as much catastrophe cover as they want, and they will need to manage their risk appetites,” he said. AM Best believes that the hardening conditions are unlikely to be a one-off and could continue for at least the next two years. “The pace of rate rises may slow down, materially in some cases, but we expect it to persist,” said Carlos Wong-Fupuy, senior director, global reinsurance at AM Best. Unlike previous cycles, hardening rates have not been driven by lack of capital but by several years of heightened losses, in particular those related to property cat risks, said Wong-Fupuy. “There is clearly a difference between available capital and deployed capacity. While most global reinsurers remain well capitalised, they have become increasingly cautious as to how that capital is deployed,” he said. Improvements in terms and conditions should attract new capital to the reinsurance market and ease capacity constraints, although the speed and nature of any capital injection is likely to be different to past market cycles, where start-up reinsurers were quick to capitalise on price increases, according to Van Slooten. Uncertainty around natural catastrophes, inflation and macro-economic volatility is making investors cautious of the reinsurance sector in the near term, he said. Some investors will also want to see that the improved reinsurance market conditions are sustainable and will translate into improved returns, he added. However, rising interest rates could help attract investor support, as higher yields on bond investments boost reinsurers investment results, added Van Slooten. While new start-up reinsurers are possible, capital is more likely to enter the market through equity investment in established reinsurers, catastrophe bonds and industry loss warranties, Van Slooten said. “We are operating in a very difficult environment, and establishing brand new reinsurers is not straightforward,” he added. AM Best also believes a sudden influx of naïve capital, as in previous cycles, is very unlikely given higher interest rates, increasing concerns over climate trends and geopolitical risks. Wong-Fupuy believes that the “readjustment” underway in the reinsurance market is healthy for both the primary and the reinsurance sector. “In order to re-align those interests, on top of higher rates, cedants have been forced to increase retentions, reduce limits, accept more restrictive coverages and in some cases lower ceding omissions,” he said. “There is a perception that for far too long primary carriers’ results may have been unfairly propped up by reinsurance support offered under too generous terms. For a number of years now we have a primary insurance sector which, in terms of profitability measures, has been doing better than the reinsurance sector,” said Wong-Fupuy. “In the past there was this excess of reinsurance capacity. It had to be deployed, and it probably was deployed on working layers where it shouldn't have been. Maybe some of those risks should have been retained in the primary sector. The primary sector got used to that, and it probably shouldn't have reached this point,” he added. The reinsurance market is now playing “catch-up” with the primary insurance and retro markets, which have both experienced price increases over recent years, explained Van Slooten. “This is a reaction to the results we have seen over the last few years, where reinsurers have been absorbing a lot of volatility and a lot of insurers have done well over that same time frame. There needed to be a rebalancing, and that is what we have seen,” he said.

Higher reinsurance costs likely to reaccelerate primary rate increases

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