Pricing momentum will be contained at 1.1 without fresh loss

Absent a major cat loss, reinsurance market conditions look set to be stable to steadily improving as we head toward 1 January, but will continue to lag the primary and retro markets.

Hurricane Dorian looks to have confirmed its status as a “near miss” for the US cat treaty market and is unlikely to disturb the dynamics at play in the mid-year renewals.

However, when a Category 4 landfall near Palm Beach was forecast market sentiment was fearful, with the ILS market’s recovery appearing fragile in the face of a potential $10bn-$20bn event.

The lack of reinsurance capital depletion or major remediation exercises, along with rising capital as bond yields fall and the challenges of pushing price on diversifying risks, point to a likely failure to obtain meaningful across-the-board rate rises.

Instead, significant rate increases will be confined to underperforming lines and clients, or mismodelled perils – paralleling the 2018 reinsurer wins which came in the Florida, California and Japanese wind renewals.

Sentiment has been improving through the year and reinsurers are deploying aggregate in a more discerning way by both market and client. No doubt Monte Carlo will see a blitz of bullish sentiment among the reinsurers which dominate the public discourse at the Rendez-Vous.

But market fundamentals do not point to a rapid acceleration of pricing momentum.

Four key areas to watch are:

  1. US casualty – Mounting concerns about loss emergence driven by social inflation could lead to accelerating excess-of-loss rate rises and ceding commission reductions to complement the primary pricing correction that has gathered pace through 2019.
  2. Retro – The degree of tightness within the retro market as the ILS market struggles after two bad years and amid scepticism on modelling and due to climate change.
  3. Wind/wildfire season – Meaningful dislocation in property cat looks possible with one more loss, and >50 percent of US windstorm risk remains at this stage, along with a menacing track that takes Typhoon Faxai near Tokyo, as well as some of the highest-risk months for California wildfire.
  4. Continental big four – Swiss Re (+30 percent), Hannover Re (+20 percent) and Scor (+12 percent) all grew meaningfully in Q2, and together with Munich Re they could slow the market if they privilege market share over rates.

State of play

Retro pricing moved meaningfully following hurricanes Harvey, Irma and Maria (HIM) in 2017, and picked up pace sharply at 1 January 2019 (+10 percent to +30 percent) as the ILS market struggled with poor results, trapped capital and redemptions.

Following gradual gains post-HIM, US excess and surplus lines pricing gains started to accelerate through Q1 and have continued through the half-year, with much property insurance business obtaining 20 percent increases, directors’ and officers’ (D&O) up 10-30 percent and in some cases general liability also able to achieve 20 percent rises.

London market insurance rates have followed a similar trajectory through the year, although there has been a time lag, and an increase of 5 percent or 6 percent looks likely as the renewal rate index for Lloyd’s at 1 January, with open market direct and facultative, cargo, aviation and D&O the drivers.

Reinsurance pricing has been much more stable through 2019, with 1 January considered a further disappointment to property reinsurers.

Since then reinsurers have exceeded expectations in Japan, where they were able to secure rate rises of 25 percent on loss-struck wind protections. They followed this up with 10-30 percent rises on Floridian accounts, and then 20-40 percent increases on treaties with California wildfire exposures.

However, crucially these victories were confined to areas with heavy losses where previous assumptions about loss experience had also been called into question by surprising loss development.

And even within these areas there has been a tendency towards differentiation by client, with worse-performing cedants paying bigger increases.

Florida rates also had an additional tailwind as a result of its status as the world’s biggest peak risk zone, and the key driver of reinsurance capital.

Contagion into low loss markets like the UK or to loss-free US nationwides was limited, or even non-existent, and as a cedant offering diversifying risk Suncorp was able to escape with a broadly flat renewal at 1 July despite hitting its programme.

To date the casualty reinsurance pricing recovery that began in Q4 2017 has been driven more by original rates than by the reversal of years of increases in ceding commissions.

And, again, the market has clearly differentiated between the better and worse lines and clients.

Primary vs reinsurance vs retro

However, the dynamics within the reinsurance sector differ substantially from the primary markets in the US and London, and from the global retro market.

Both the primary markets referenced and the retro market have seen significant capital withdrawal via either capital depletion or dramatic remediation work.

AIG laid bare the degree of its remediation work on its second-quarter earnings call when it said it had cut back limits deployed through Lexington by half, as well as reducing its overall North American property limits by more than 60 percent.

Lloyd’s, meanwhile, has seen dozens of exits from individual lines as part of the performance gap process, provoking a sharp and widespread contraction of available capacity.

And retro has seen both huge amounts of locked capital and the withdrawal of Markel Catco, a circa $5bn player in a $20bn market.

Reinsurance has not only lacked the same capital depletion, but it has seen the reverse, with falling bond yields and retained earnings pushing reinsurance capital 8 percent higher to $559bn by the end of H1, according to Willis Re figures.

The market is also poised for the arrival of Convex, Stephen Catlin and Paul Brand’s $1.8bn start-up, which will be fully up and running for 1 January after writing around $25mn of cat business at mid-year.

Continuing excess capital and the relatively low level of contagion to diversifying markets that do not drive capital requirements and to “good” clients probably represent a reasonable predictor that – absent a loss – there will not be meaningful blanket rate rises.

Instead, there are likely to be strong pockets where rate rises are needed, and cedants which are adversely selected against by reinsurers that are focusing their capacity on preferred clients.

Most of the US casualty market, excluding workers’ compensation, could fall into this category, as elevated jury awards hit the general liability and healthcare markets, and losses emerge from the opioid crisis and sexual molestation cases.

ILS fragility

Nevertheless, the current market dynamics seem more sensitive to further cat losses than the excess capital position of the market might suggest.

Discussions with reinsurers and brokers as Dorian threatened the Florida coast as a Cat 4 storm suggest the market is fearful of another loss year.

In particular, the ILS market looks to be in a fragile state as it continues to work through the fallout from the 2017 and 2018 losses.

After two years hit by trapped capital, ILS funds and reinsurers with third-party platforms or sidecars badly need to be able to roll over capital into 2020.

Given the way that the trapping mechanism works, even a $10bn-$20bn event could result in significant trapped capital, particularly if it is via a Florida storm where ILS is exposed across a range of different strategies.

Despite a very tight retro market, it has been all but impossible to raise new money to put to work in the sector amid investor scepticism resulting from Markel Catco’s collapse, climate change and model misses.

Even with a clean calendar year for cats, with Swiss Re pegging H1 losses at $15bn versus a 10-year average of $31bn, the Eurekahedge ILS Advisers Index shows the market delivering a year-to-date return of -0.71 percent.

Analyst sources said that cat bonds currently have a meaningful positive spread versus similarly graded corporate debt, but are still struggling to attract new interest.

The ILS market has been the biggest driver of the reduction in cat reinsurance rates since 2012, and if capacity in the $90bn market is scaled back substantially then rates would rise.

The Dorian impact on reinsurers will clearly be muted. AIR Worldwide’s $1.5bn-$3bn insured loss estimate tallies with the $1bn-$3bn estimates in the market, with the loss likely to skew towards quota share reinsurers of local players.

In the US and Canada, relatively little of the primary losses is likely to reach reinsurers, which tend to pick up losses only in excess of $5bn for a non-Florida storm.

Hurricane Matthew in 2016 showed near-miss events have next to no impact on rates.

Nevertheless, the emergence of Fernand and Gabrielle over the last week demonstrate that conditions are still conducive to storm formation.

Along with the remainder of the period of elevated wildfire risk in California and the typhoon season, reinsurers are a long way from home for 2019.

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