The world’s reinsurance market players will meet in Monte Carlo to kick off what promises to be tough end-of-year renewals discussions, with reinsurers fretting about the impact of inflation and rising interest rates and looking for ways to improve their performance despite steadily increasing exposures.
“The reinsurance market is under quite a lot of strain” says Mike Mitchell, Head of P&S Underwriting, Reinsurance, at Swiss Re. “We've had several years of underperformance relative to our client base, as well as to the targets that we have as an industry.”
Although reinsurers’ results improved in 2021, despite heavy catastrophe losses and COVID-19 claims, it can’t be seen as a good year for the industry, says Bertrand Romagne, CEO, International Reinsurance at AXA XL Reinsurance. “If we look at the ROE that companies have produced over the past eight years, for example, there’s been a mix of good years amongst a number of challenging or less satisfactory ones, in terms of not rewarding the cost of capital.”
That is the nub of the industry’s problem, says Johannes Bender, a director at S&P Global Ratings. Its inability to earn its cost of capital is why the rating agency has the industry on a negative outlook. “More than 20% of the top 21 reinsurance companies are on a negative outlook or CreditWatch negative. What we’ve said would be a trigger for us to potentially revise the sector outlook back to stable is if the sector sustainably earns its cost of capital.”
Although rates have been increasing in recent years, it still isn’t clear the industry will deliver better returns this year. “While we believe that the losses from the Russia/Ukraine conflict will be manageable for the reinsurance sector, the hurricane season and winter storms in some parts of the world will be decisive for whether the industry can meet its cost of capital. The capital markets are also quite volatile,” says Bender.
James Vickers, Chairman of International Reinsurance at Gallagher Re, says: “The market is delicately poised. It’s always sensitive to losses but rising interest rates and inflation now add a completely different, more volatile dynamic. If the estimates reinsurers have made about the effect of these prove to be incorrect over the next six months, irrespective of whether the second half of 2022 has relatively few losses, any instability coming from those two factors will directly impact the market. The days of reinsurers being able to absorb significant volatility without adequate returns are over.”
Prices are likely to increase against such an uncertain background, says Romagne. Mitchell adds: “It's inevitable that the theme of Monte-Carlo will be increases in reinsurance prices, as we're seeing several accelerating loss cost drivers. The industry needs to generate improved margins as well as pay for an increased risk landscape.”
Patchwork, not blanket price rises
Predictions that market cycles are over – thanks to the influx of alternative capital – haven’t turned out to be true. But the picture across the market is more of a patchwork of price rises than blanket increases. “Twenty or 25 years ago, a hard market was far cruder; all buyers got painted with the same brush,” says Vickers. “It’s more sophisticated now. So, we now have pockets that are quite difficult and while everywhere else might no longer be enjoying rate reductions, they're not seeing significant rate increases either. And, compared to the last hard market, the reinsurance market's access to capital has also got a lot more sophisticated.”
Mitchell agrees, saying: “What’s different now from previous hard markets is just how much non-balance sheet capital has been supporting the cat market. The speed that capital moves in – and out – is quite dramatic. I think that the current market situation has really been exacerbated by a shift in risk appetite, particularly in the cat space.”
Romagne says: “Previous hard markets leaned more towards large losses and a shortage of capital. However, this time, the industry continues to remain well capitalised, and the large losses are more a result of unprecedented events.”
Mitchell is reluctant to be drawn on where the market is now – or where it might go in the end of year renewals. “I like to think less in terms of hard and soft markets and more in terms of sustainable pricing environments for both buyers and sellers. To reset to a situation in which the reinsurance industry can continue to do what it does, we must be able to attract capital that isn’t just in short term liquid instruments such as cat bonds, but also will support balance sheets, to give our clients greater certainty that capital is available for them.”
Price rises are imminent
With reinsurers looking anxiously towards a clouded horizon, cedants are braced for rate increases. “I think most of our clients probably recognize that they won’t see the same sort of rate reductions they've had over the last five years,” explains Vickers. “But how much of an increase they are going to face is dependent on territory, class, and product.”
Specialty lines, like D&O and general liability, remain under pressure. But with catastrophe losses exceeding the ten-year average for five of the past six years, how much of this kind of risk reinsurers are willing to take and at what price will be hot topics in Monte Carlo.
“We're seeing a significant shift in the type of cat losses,” says Mitchell. “Ten or 15 years ago, 80% of the cat loss burden that hit the reinsurance industry was from primary perils, like major hurricanes and earthquakes. Now, it’s more like 50/50 between primary and secondary perils, like floods, hail, winter storms and wildfires. There’s a clear correlation to climate risk and demographic change, but also social inflation, which is playing out most strongly in Florida. I'm not going to guess whether this is the new normal, but if you start to see patterns and trends developing, as we have, I think you'd be heroic to assume that it’s just a blip.”
Increases in economic values mean catastrophe claims are always getting bigger, argues Vickers. “The question is will they do so at a faster rate than they've done in the past? It will boil down to how primary companies manage their retentions, and where reinsurers want to start giving cover. Low level, frequency covers are getting very difficult to place. Reinsurers don't want to expose themselves on very low layers, they feel that these should be within the primary company’s retention.”
But, if anything, insurers are looking to buy more reinsurance cover, not less. “There is a trend to buy more reinsurance where possible, which is why primary companies will fight quite hard to retain their aggregate and low-level covers, because they're very helpful for them in managing their volatility. But, at the same time, with inflation driving insured values, companies do need to find a more tail cover, because the numbers from 1-in-100 and 1-in-200 events are getting bigger,” says Vickers.
“There is a trend to buy more reinsurance where possible, which is why primary companies will fight quite hard to retain their aggregate and low-level covers, because they're very helpful for them in managing their volatility. But, at the same time, with inflation driving values, companies do need to find a bit more tail cover, because the numbers from 1-in-100 and 1-in-200 events are getting bigger,” says Vickers.
There are set to be plenty of high-stakes negotiations taking place this week in the high-rollers’ paradise.
