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How long can the reinsurance market defy gravity?​​​​​​​

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The reinsurance market experienced its first broad-based rate upturn in 15 years amid the Covid-19 pandemic, but momentum is already ebbing, raising questions over whether sustained market gains can persist into 2022.

Briefly, those who are arguing for ongoing hardening, such as Swiss Re, point towards the post-pandemic risk of inflation sharpening the existing increase in claims cost from social inflation. Concerns around climate change and elevated catastrophe costs are another highly visible factor.

They note that up to this point, the market hardening has not been driven by supply constraints anyway – that it has been a discipline-driven upturn that should be able to sustain itself.

But brokers say that a year on from the pandemic, reinsurers are showing few signs of this increased risk aversion in practice – meaning that over-supply of capacity is likely to return to being a more significant factor in the market dynamic.

They note that concerns about inflation risk are somewhat offset by eased fears over Covid exposure and mark-to-market equity investment losses repaired since last year’s peak fear point.

Even so, the view on the outlook appears to be finely balanced, suggesting that if further gains are not achievable, the market may continue to defy gravity and sustain current pricing levels for longer.

Negative indicators

It does not take long to look for negative indicators to suggest that the small “wholesale” reinsurance market will be quickly back to its default sluggish position seen for so much of the 2010s.

Heading into this year, reinsurance capital levels were already ahead of pre-pandemic levels.

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Take the result of the Florida reinsurance renewals – admittedly a market that had far bigger gains than the wider cat market last year, but which is also far more vulnerable to loss inflation. This year overall rate change fell back to mid/high-single digits – up to 10 points lower than early hopes.

Even on the casualty side, where some participants see a better chance of rate gains persisting, quota share ceding commissions have begun to rise in favour of buyers.

And on the more commoditised cat bond market, sponsors have regularly been able to get away with deals well below their initial expectations, with a few US wind bonds clearing at 3% or as low as 2.25% – close to pre-Irma levels. Industry loss warranties, too, are sliding quickly back from last year’s peak.

But that overall picture may hide more complex nuances, sources said.

“The easy soundbite is things are levelling off, but I’m not sure it’s accurate,” said one senior reinsurance executive.

The property market is much more vulnerable to a quick reversion to softening because of the wider number of capacity providers supporting it, whereas the smaller-scale casualty market and some pockets of specialty business were seen as more likely to continue holding ground.

As well as a more commoditised supply side, this also reflects the greater vulnerability to inflation for casualty lines, or post-Covid risks for the likes of surety and trade credit reinsurance.

But even within the property catastrophe market, underwriters point out that although overall there is plenty of capacity, this appetite is also dependent on price and level of risk.

Aggregate covers, with their greater volatility, and low-lying attritional Florida covers are still hard to place.

And despite new entrants to the market, sources say there has been little evidence of “foolish” behaviour from underwriters trying to undercut competition. Despite the contribution of capital from new start-ups, they were not seen as a primary driver in the slowing pace.

Moreover, while the cat bond market may have already quickly lost ground, most did not see it as a harbinger of where the broader market would head, beyond the remote risk cat perils where it specialises.

The cat bond market is a better signal now of trends within the credit market than a leading signal for the rest of the cat reinsurance sector, said Guy Carpenter chairman David Priebe. “There will be a continued gap between 144a cat bonds and traditional markets.”

However, with reinsurers loading up on retro coverage from the ILS market, it could fuel more capacity and competition, a senior underwriter said.

The case for stability

The case for rates to hold their ground or continue making incremental gains rests largely on macro factors – a persistent low-yield investment environment that pushes carriers to work for more underwriting return and a higher baseline of risk whether due to climate factors or legal award inflation.

Other than the increasing visibility of concerns about climate change and post-pandemic inflation fears, many of these challenges are not new.

But to some extent this view that post-Covid increases can endure is supported by moderate broker projections for the outlook, with little bullish talk about unwinding gains made in the past year.

HX head of analytics David Flandro believes that there are parallels in the current situation to the 2002-2003 era, when market hardening was prolonged beyond initial expectations – although he notes that was driven by the 2004-2005 hurricane season.

You've got the macroeconomic conditions to sustain [rates]. Reinsurance had got to a very low base, and there’s been a reversion to the mean
David Flandro, HX

Without a similar catalyst, rates increases will continue to moderate, but if catalysts emerge, he believes that the market can maintain the levels it has returned to. He puts this roughly in line with the 2012 Superstorm Sandy era, some way below the post-Katrina peaks but still relatively elevated above the 30-year averages. “A very large loss now could drive rates to near, maybe above all-time highs.”

“And you've got the macroeconomic conditions to sustain it,” he said. “Reinsurance had got to a very low base, and there’s been a reversion to the mean.”

He argues that post-Covid economic expansion is bringing more premium dollars into the primary market, supporting reinsurance in turn – a factor other people saw as particularly relevant on casualty pro-rata business.

“The world economy is going be in a short-term growth position in 2022 and 2023 and insurance is a nondiscretionary purchase,” Flandro said.

Guy Carpenter is also anticipating a more stable outlook in the near future, barring any unforeseen events, said Priebe.

He said that pricing ranges have become narrower and that the market has remained “extremely orderly” despite ongoing discussions about elevated risk levels.

“We’ve seen very consistent behaviour,” he noted.

The firm’s head of global risk solutions, Ed Hochberg, said that after a phase of an “orderly rising market”, it was healthy that pricing had begun to taper as continued increases could lead buyers to look for alternatives.

Pressure points

This point on sourcing alternative cover was echoed by Gallagher Re CEO-designate Tom Wakefield, who suggested that buyers may be more open to switching up their panels and programmes as they emerge from Covid.

In the past year there had been a flight to quality reinsurers as buyers were prepared to pay more to trade with long-term counterparties, but he said this was a “one-time exercise” and further rate gains could be suppressed by new competitors, or by cedants moving around panel providers.

"Our clients have been through a very difficult underwriting environment themselves,” he noted, adding that cedants were looking to ensure they were retaining the benefit of price gains at the primary level.

“There’s limited reason to increase pricing because of an underlying increase in risk unless you have loss activity that supports it,” he said, adding that the underlying changes to terms to improve portfolios would also benefit reinsurers.

Primary carriers have substantially rewritten their portfolios and tightened conditions – it changes the risk profile [for reinsurers]
David Priebe, Guy Carpenter

Guy Carpenter’s Priebe agreed that the discussions around elevated risks are mitigated by changes enforced by insurers.

"Primary carriers have substantially rewritten their portfolios and tightened conditions – it changes the risk profile [for reinsurers].”

M&A at the insurance level (such as the Westpac insurance book in Australia, or Metlife’s US P&C business) was also cited by a couple of underwriters as a potentially suppressing influence on rates, as reinsurers face the loss of premium income from those clients.

Indeed, although capital levels are healthy, many reinsurers are choosing to focus on primary insurance growth – as Everest Re emphasised in its investor day presentation this week.

Covid and catalysts

Ultimately the year since the pandemic correction kicked in has also brought major changes – and while some see Covid as a factor that may sustain rate gains, others see the evolution since its initial outbreak as a mitigant.

Particularly for European cedants, where uncertainty around potential BI exposure was set aside at 1 January to allow for ongoing renewals, negotiations are likely to come to a head before the next renewal.

And if reinsurers pick up extra-contractual losses, it will be hard for cedants to suppress a rate reaction, they argue.

But stepping back, the overall loss – at nearly $40bn roughly, including significant IBNR headroom – has come in well below initial upper end fears that tipped the scales at $120bn-$150bn.

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Initial mark-to-market investment losses have also rebounded.

Versus the period where “people were genuinely worried,” the post-Covid recovery has changed the outlook, said Flandro.

“We’re in an environment of relative stability where we can plan for the future.”

Ultimately, this has brought some reinsurers back to the view that the discipline-driven market could begin to crumble.

“Oversupply weighs against everything,” one senior reinsurance underwriter said.

But with the market finely poised – one underwriter described it as fragile – a catalyst may not need to be a big one to skew the balance back in reinsurers’ favour, particularly as there is now less low-lying or aggregate retro cover in the market than in the Catco days.

Winter storm Uri has already put carriers above Q1 year-to-date cat loss budgets for the year, although lower than projected rate increases have led underwriters to chase their business plan premium budgets regardless.

“When will the penny drop that people are going to run [combined ratios in the] 110s again?” one questioned.

Web

The Aon Benfield aggregate delivered an average combined ratio of 100.6% in the past five years, arguably a fair performance in light of the heavy catastrophe loss activity.

Conclusion

In the initial pandemic outbreak, there were some who saw this as a market that would offer opportunity for reinsurers for several years.

Perhaps the bigger underlying question is what the ebbing momentum showcases about the market. Perhaps it can be seen as evidence that it is firmly in a new flexi-capital era where pricing will trade in a tighter range than before the advent of the ILS market.

Or simply that the market quickly regained levels that brought it decent yields, although the carriers that have a more bearish view on the new baseline levels of anticipated cat activity may disagree with that.

Regardless, it seems that holding firm in 2022 would be considered a stronger outcome than many would have imagined this time a year ago.

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