The run-up to 1 January will be marked by a “logical and sensible” reinsurance market, with carriers striving for adequate pricing as they counter low investment returns, according to Willis Re’s James Vickers.
In an interview with this publication following the release of Willis Re’s half-year reinsurance market report, the broker’s international chair said that reinsurers’ underwriting performance had improved on an underlying basis in H1.
The report found that on average, global reinsurers’ underlying combined ratios (CoR) – normalised for the impact of Covid-19 – had improved by 1.9 percentage points from the prior-year period.
“What you’re beginning to see is rate increases that have gone on in the last 18 months,” said Vickers, explaining the improvement.
“Expense ratios are beginning to come down; not to deride the effort that reinsurers have made to reduce their expense ratios, but the reality is that the biggest thing to reduce expense ratio is to write more premium and get rate increases. That’s beginning to go in the right direction for the first time in a long time.”
The improvement in underwriting performance had not, however, been enough to help carriers make back their cost of capital. The report found that in H1 the average underlying return on equity of reinsurers in Willis’ index was 2.8%, a drop from 4.2% during the same period last year and far below the average cost of capital of around 7%-8%.
The difficulty facing reinsurers in H1 was drastically reduced investment returns, not only due to the market rout in the spring as investors reacted to Covid-19, but also due to continuing low interest rates, Vickers said.
“This consistent low interest rate is really beginning to bite,” he said.
“The average reinsurer has a four- to six-year investment lifespan, so even when interest rates start going up again, it’s going to continue on that basis for a number of years.
Vickers predicted that 1 January discussions would centre on reinsurers striving to counteract the impact of the investment market conditions through firmer pricing. He added they would target CoRs “not in the mid- to upper 90s, which we could live with because we had nice investment income”, but significantly lower.
“It’s going to be about understanding what you’re underwriting and margin,” Vickers added.
Covid-19 losses
The report noted a wide range of Covid losses between the major reinsurers in its index, with the impact on different carriers of the losses ranging from around five to 20 points on their CoRs.
“Covid reporting is tricky, as [carriers] are taking different views on what to do,” said Vickers.
The executive explained that the “vast bulk” of losses carriers have so far flagged are on an incurred-but-not-reported (IBNR) basis. On short-tail lines, aside from where there is ongoing litigation around BI, there is relative clarity about loss figures.
The real difficulty in seeing the impact of Covid-19 lies in casualty, Vickers said.
“In casualty nothing has really appeared yet. We all know it’s going to come but we’re not quite sure in what form. There is a much broader set of opinions you can take,” he said.
“You’ve got some who are being very conservative and saying, ‘We’ve got these classes of casualty, we need to put up this reserve now’, and others are saying, ‘We haven’t got enough information to justify putting up a reserve’.”
Vickers said the weight of opinion in the market has settled on a Covid-19 industry loss range of $40bn-$60bn, but the lack of clarity around casualty throws this into question.
He added there is still low visibility around the share of Covid-19 losses that the primary and reinsurance sectors will take.
“Normally, you would get a $60bn loss and people would say, on average the primary market will retain $20bn and the reinsurers have $40bn. We don’t know in this case,” Vickers said.
“Each [reinsurance contract] is unique in its own right. What’s in the contract language? What does the original policy say? How was the lockdown in that country announced? There are all these things around triggers, hours clauses and event definitions.”
ILS and trapped capital
Willis Re’s report found that alternative capital had reduced by around $3bn, or 3.3%, to $88bn in H1 compared with the prior-year quarter.
While the broker did not provide a breakdown of how much of this capital had exited the marketplace, Vickers said much of the reduction was due to capital lock-ups.
“The underlying story of ILS is that, certainly if you were invested in the right products and particularly the liquid publicly traded cat bonds, it’s a pretty good story,” he said.
“In March, it was one of the few asset classes that wasn’t affected [by Covid-19]; you could get liquidity and by and large they have performed exactly as you would expect.
“We don’t subscribe to the view that there are lots of people running away from ILS and they don’t like it. We think there’s a very strong underlying interest in it as an asset class, it’s just that the ILS investors are getting a lot smarter about who they will back and the type of structures they want to invest in.”
Market conditions
Despite the impact of Covid-19, and the cumulative effect of cat events such as hurricanes and typhoons in 2017, 2018 and 2019, Vickers said the market was not as hard as it had been in previous years.
Although some industry figures have compared the 2019 market to that of 2005, following hurricanes Wilma, Rita and Katrina, or even of 2001 following 9/11, Vickers pointed out that the capital base of the sector was broadly stable.
“A few people hark back to past hard markets [such as after 9/11] but that was a capital constrained market; capital just wasn’t available,” he said.
At the same time, Vickers rejected the idea that the new capital coming into the market from both new entrants and established players was enough to push down pricing.
“We think it’s going to be a logical and sensible market,” he said.
“If you look at the amount of new capital coming against the current capital base, and you look at the type of people who are attracting the new capital, they are not in the game of undercutting the market. They will want to ride whatever benefit there is in the market.”