Underwriting ‘complacency’ suggests need for reinsurance price rises, say ratings agents

Reinsurers have not adequately priced for rising catastrophe exposures and climate change, which could lead to future rate increases, according to ratings agents. Reinsurance pricing has increased at recent renewals. This is in large part a response to record catastrophe losses in 2017 and 2018. Those two years combined generated losses of $200bn for the (re)insurance market, the most costly two-year period ever for insured natural catastrophes. As a result, non-life reinsurance pricing appears to be developing “more favourable momentum” for carriers, according to AM Best in its just-released reinsurance market report. “Rates have improved modestly, with the industry reminded by catastrophes in 2017 and 2018 that $200bn of losses can occur over a very short period of time,” it says, ahead of the Monte Carlo Reinsurance Rendez-Vous de Septembre. Prices for reinsurance property catastrophe business have been rising since January 2018, reversing a period of softening that began in 2012, according to ratings agent Moody’s. “The turnaround comes in response to high catastrophe losses, rising demand from primary insurers, as well as alternative capital providers' tightening risk appetite,” it said. According to S&P, the global reinsurance market will continue to firm during the forthcoming renewal season but – unlike the primary market – cannot yet be described as hard. And despite price increases, reinsurance ratings are still at relatively low levels, especially given heightened natural catastrophe losses. Even with recent increases, US and global property reinsurance prices remain approximately 20% below pre-2012 levels, according to Moody’s. Recent price increases have also been largely confined to loss-affected property exposures, namely US hurricane and Japanese wind. Cat loss-affected property lines rose by up to 20% in the July 2019 renewals, building on a 10% increase in July 2018, according to Moody’s. However, prices on loss-free property lines were flat on average through the 2018 and 2019 contract renewal seasons. Meanwhile, specialty and casualty excess-of-loss reinsurance has not experienced significant increases, despite some concerns about rising loss cost inflation, said Moody’s. “While prices for property catastrophe exposures have been rising, the increases have been dampened by the ample supply of alternative capital available to cover natural catastrophe risk. Prices have become less responsive to large natural catastrophe events over time, with Hurricanes Harvey, Irma and Maria in 2017 prompting a far more moderate increase than Katrina, Rita and Wilma in 2005,” Moody’s said. Third-party capital has provided “ballast” for traditional reinsurers to continue to offer property catastrophe capacity to clients despite the rate pressures, according to AM Best. Global reinsurance capital stood at an estimated $438bn in 2019, of which traditional reinsurance capital accounted for $346bn and third-party capital $92bn, it noted. “The growth of third-party capital is expected to continue, but the pace is likely to slow, following the frequency and severity of loss events in 2017 and 2018, owing to the improving but still relatively anemic pricing improvement,” said AM Best. The ratings agent highlighted an apparent return of underwriting discipline in the reinsurance market but questioned the sustainability of price increases, given high levels of industry capital. It argued that rates continue to be driven by supply and demand, rather than risk-based pricing. “Third-party capital providers and traditional reinsurers held capacity back at the mid-year renewal for US and Japanese programmes. But this newfound discipline is once again being driven by the same old supply/demand equation as much as by pricing models,” AM Best states in its report. “It was apparent at the last January renewal that pricing for both property catastrophe and longer-tailed classes of business remained weak despite the series of losses that had previously transpired. The rationale for the status quo then on pricing was ample capacity despite losses, rather than acceptable return for the risk. The next question that arises is: how sustainable is this newfound underwriting discipline and how will market participants react if overcapacity begins to push pricing to irrational levels again?” it adds. AM Best also suggests that increased reliance on alternative capacity may have led to complacency in the market, which has failed to adequately price for catastrophe risks. “The natural catastrophes in 2017 and 2018 clearly illustrated the increased participation [of alternative capital] in these losses, mostly through the use of collateralised retrocession placed by traditional reinsurers. While this form of alternative capacity served to insulate the traditional market from excessive losses, it also delayed an adequate response to obtain higher risk pricing following the 2017 catastrophe losses,” the ratings agent says. Loss creep, particularly from Hurricane Irma in 2017, showed how the market failed to price for changes in the Florida property market, according to AM Best. The 2018 wildfires in California and Typhoon Jebi in Japan also caught many reinsurance underwriters and capacity providers by surprise due to a failure to appropriately manage and adequately price for the actual underlying risk, it adds. Typhoon Jebi, the strongest typhoon to strike Japan in the last 25 years, led to the most expensive insured typhoon loss. The storm has seen a number of reinsurers and insurers report higher-than-expected losses in 2019. This is due to uncertainties around business interruption and contingent business interruption losses from industrial risks, as well as supply chain disruption linked to flooding at Kansai Airport. Initial loss estimates for Typhoon Jebi were $3bn to $5bn, yet the most recent loss estimate has risen to $12bn to $13bn, with some reinsurers bracing for a higher settlement, close to $15bn–$16bn. “The industry continued to rely on existing inadequate models and underwriting tools that failed to keep pace with the changing dynamics of the true exposure. In all these circumstances, one can point to complacency that built up during previous years of benign loss activity. It proves that models are no substitute for individual risk underwriting and purely relying on modelling can be a recipe for disaster,” AM Best states. Moody’s has also said that reinsurers’ profitability is currently insufficient to absorb above-average losses. “Despite recent price increases, reinsurers are not making sufficient profit to provide an effective cushion against above-average catastrophe years. They therefore remain vulnerable to significant earnings volatility and even capital erosion in high loss years. In the absence of further price increases, double-digit returns on equity will remain elusive for many firms, even in years with average catastrophe loss activity,” it said. Both Moody’s and AM Best believe climate change will remain a significant challenge for the entire reinsurance industry. Wildfires, more intense rainstorms and flooding are all expected as the climate warms. Reinsurers are increasingly focused on mounting climate change risks, Moody’s said. For example, reinsurers have been re-evaluating exposure to wildfire risk as the current high incidence of severe fires is likely to continue. “Reinsurers are exposed to climate change through an increase in the risk and unpredictability of natural catastrophes, environmental liabilities, potential declines in the value of carbon-related investments, and increased regulatory scrutiny. Climate change also makes the frequency and severity of natural hazards less predictable,” according to Moody’s. It added that risks related to climate change will be manageable for reinsurers for at least the next five years, but some may become uninsurable over time. “Reinsurers' relative resilience to the increased frequency and severity of natural hazards mainly reflects their ability to reprice property catastrophe cover, and adjust their risk exposure, on an annual basis. However, more extreme warming scenarios could render certain risks uninsurable in the longer term, shrinking the pool of insurable risk,” Moody’s said. Other factors could also support rating momentum going forward. Pressure on interest rates, resulting from the prospect of slower economic growth globally, should foster greater discipline to produce underwriting profit, according to AM Best. Pricing momentum could also be driven by potential loss cost inflation, coupled with lower loss reserve redundancies or reserve deficiencies in casualty classes where pricing had been overly competitive, it adds.

Underwriting ‘complacency’ suggests need for reinsurance price rises, say ratings agents

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