Monte Carlo lessons: Retro, US casualty, U-shaped pricing, 2020 remediation
After more than 100 background meetings, as well as a raft of interviews and press conferences from most major reinsurance market players, we have a better feel for many of these questions than before.
There was less electioneering from reinsurers on pricing than might have been expected, and this strengthens the impression that, absent another cat loss, the rating environment will be stable to modestly up at 1 January, with pockets of repricing for badly performing lines, geographies and clients.
Retro remains an area of intense interest and major uncertainty, with supply and pricing highly sensitive to losses later in the year, but a number of retro fundraises are underway – all of which will have to find a way to overcome extreme investor scepticism about the segment.
Further portfolio remediation within primary lines is expected, with AIG signalling a likely continuation of its drawback into 2020, and others like Swiss Re Corporate Solutions expected to drop limit next year. Whether Lloyd's emerges in growth mode from the 2020 business planning process is a key question for London market pricing dynamics.
As such, and with a lack of major remediation work seen in reinsurance, it seems likely that the "U-shaped" (Greg Hendrick, Axa XL) pricing environment – whereby reinsurance will lag primary and retro rate gains – will continue into 2020.
The private noise around loss emergence on the US casualty book for the accident years in the 2010s is even worse than the public commentary, with fears that mounting "auto-like" severity in general casualty and medical malpractice resulting from spiking jury awards will hurt results in a big way over the next few years. The market's ability to quantify the problem seems low, with various senior sources saying that we will only know the scale of the problem after the event.
As well as retro, the ILS market is closely watching forthcoming issuance in 2020 as a maturity peak hits next year following low 2019 volumes. Announcements from Scor and from LGT also seemed to point towards even further blurring of the lines between traditional and ILS players, with both companies looking at using the mechanics of balance sheets to write risk supported by third-party capital.
Rates set to rise sharply again after major increases in 2018 and 2019
Third-party investors sceptical given poor performance, Catco's issues and climate change
A number of fundraises underway including Eklund and Markel's Lodgepine
With Aon estimating trapped capital at around $15bn, two years of swingeing losses for retro writers and Markel placing Catco into run-off, there is a broad expectation of major rate rises again within the circa $20bn-limit tertiary market even without another cat.
The market is likely to be highly uneven, but one executive at an ILS fund that writes retro estimated a bounce of 10-20 percent. A Bermudian reinsurer also forecasted a 10-15 percent increase on ultimate net loss and 25 percent on aggregate covers – which have performed worse. Others believe the effective rate rises could be far higher than this due to the scope for moving up attachment points and capping direct and facultative (D&F) exposures.
New capital formation to date has been virtually non-existent, with investors highly sceptical in the face of uncertainty around models, weak performance and mounting fears around climate change, with fundraising efforts also hurt by outflows of money from active strategies.
Former RenaissanceRe CUO David Eklund is the highest profile fundraiser, and is working alongside former colleague Jayant Khadilkar, ex-president of RenRe Investment Managers and most recently head of analytics and technology at TigerRisk Partners.
Sources have said that Aon is involved in the raise, with a target of in excess of $500mn.
Eklund has a longstanding relationship with Warburg Pincus from the RenRe and Aeolus days, and sources said the private equity house – which has just backed Steve McGill’s broker start-up – is interested in a retro play.
Markel is also raising money for its new vehicle Lodgepine Capital, having named Andrew Barnard – veteran of multiple iterations of the New Point sidecars Markel ran with Stone Point – as CEO.
At least one other retro vehicle is understood to be fundraising, but broking sources believe that there are more under development.
Retro-specific fundraising is set to be highly challenging, possibly giving an advantage to managers that have higher risk funds that allow them to write across both first-tier cat reinsurance and retro, like AlphaCat.
US casualty lines
Private commentary on US loss emergence is more fearful than what is said in public, with concern that accident years from roughly 2010-12 onwards will worsen significantly
Pressure on reserve releases going forward is becoming increasingly certain, with scope for reserve strengthening to occur
The impact from the US opioid crisis and sexual molestation is yet to be seen, and could amplify existing loss-cost trends
Companies including Travelers, Chubb and WR Berkley have all addressed elevated jury awards in the US publicly in recent quarters, with Bill Berkley saying earlier this month that juries are looking to "punish" companies.
Swiss Re's group CUO Edi Schmid added his firm's voice to the chorus at Monte Carlo, noting that the median award from the top 50 US verdicts in bodily injury cases had doubled between 2014 and 2018.
The private commentary is even more negative than what has been said in public, and fear is growing that the accident years from around 2010-12 onwards will worsen significantly as a result of elevated severity.
One senior source said that even relatively vanilla bodily injury claims are starting to stretch high up casualty towers into the excess layers, prompting a major rethink around these exposures.
Market sources seem more comfortable about the reserving position than they were in the late 1990s, but concern is growing and there is a high degree of uncertainty around how bad recent accident years could get.
As such, pressure on reserve releases going forward is certain, along with future loss picks, with scope for insurers to have to strengthen overall reserves.
The impact will be highly asymmetric based upon portfolio construction, and the degree of pain will also reflect how conservatively the impacted accident years were initially reserved.
These concerns reflect the state of play ahead of the crystallisation of the impact from the opioid crisis and sexual molestation. Market sources expect the industry to ultimately be tagged with significant losses by both, but the picture remains hazy.
Emergence of a “U-shaped curve” whereby reinsurance pricing lags that of insurance and retro
The market is sceptical that the rate rises seen in Florida and Japan will translate to the European cat market at 1 January, with a flat renewal expected
In Japan, the combination of Jebi creep, model scepticism and potential Faxai losses could trigger fresh rate rises
Reinsurers did talk about the need for rate increases publicly and privately, but the lack of emphatic statements about the need for blanket rate rises was quite telling, with Munich Re choosing to focus on cyber and Swiss Re talking about issues including the protection gap and analytics.
The decision to focus messaging at the conference elsewhere can be read as an attempt to avoid over-promising to investors at a point where portfolio remediation has been largely a primary phenomenon and capital destruction a retro market trend.
Absent further loss activity, broad-based reinsurance portfolios still seem likely to show a few points of improvement year over year, buoyed up by underperforming areas and a more discerning attitude from reinsurers when it comes to deploying aggregate.
Axa XL CEO Greg Hendrick gave us a new term to describe the asymmetry of rate movements between the first, second and third tier markets.
He told this publication in an interview that the industry was seeing "an inverted rate increase curve" – describing the "U-shaped curve" as "unusual".
A succession of market sources including reinsurers, brokers and buyers expressed scepticism that there would be pricing contagion from hotspots such as Florida and Japan to European windstorm, the largest 1 January cat renewal.
After another clean year for European windstorm, sources are predicting a flat renewal, or possibly modest risk-adjusted reductions if reinsurers can be persuaded to throw in exposure growth for the same premium spend.
There was also scepticism that reinsurers would be able to force through rate rises on loss-free US cat programmes, particularly for nationwide players, although as the year progresses the delayed effect from the increased cost of retro could make some impact on treaty pricing.
There is an expectation of major rate rises for Japanese clients based on the doubling of the Jebi loss post-renewal to around $15bn, with the loss handed dollar-for-dollar to reinsurers. Some in the market believe the combination of the creep, scepticism around the models and what could be a first-layer loss from Faxai will prompt not only a fresh 25 percent rate rise on wind layers, but contagion to earthquake pricing.
Bullish statements from Aon and Guy Carpenter that ILS issuance will rebound next year
Scor and Schroder Secquaero indicate an interest in raising money from ILS investors to fund rated balance sheets
ILS market travails arising from the 2017/18 cats and Markel Catco have been heavily covered, and clearly the market remains relatively fragile, but there were two important developments.
First, Aon and Guy Carpenter made bullish statements about volumes in the ILS market and predicted that issuance would rebound in 2020.
Guy Carpenter's head of ILS origination Cory Anger said that there would be a spike in maturities in 2020 with 15 percent of on-risk bonds due to roll off in Q2 alone, and said that the pipeline from renewing and new issuers was gaining momentum.
Second, both Scor and Schroder Secquaero indicated an interest in raising money from ILS investors to fund rated balance sheets.
Scor announced an ambition to expand its third-party capital strategy beyond managed funds to include a balance sheet component. This is part of the firm's new strategic plan that runs to the end of 2021, and the reinsurer said it expected the initiative to materialise towards the end of that period.
The nearest parallel for Scor's ambition is believed to be Vermeer Re, a separate balance sheet established in late 2018 by RenRe to write on behalf of Dutch pension fund PGGM.
Schroder Secquaero, fresh from the buyout of the remainder of the management stake by Schroders in July, indicated that it was also exploring establishing a balance sheet, although details are scarce and the ILS manager is thought to believe conflicts of interest need careful management.
If Schroder Secquaero proceeds it would join Credit Suisse Asset Management and LGT as ILS funds with rated balance sheets.
The challenges posed by locked capital over the past two years have emphasised the advantage of rated balance sheets, which also include leverage and capital diversification.
The potential moves from Scor and Schroder Secquaero seem to point towards a convergence of the capabilities, legal infrastructure and capital bases of the traditional and ILS markets over time.