Reinsurers braced for storms ahead
Global political and economic issues create a turbulent outlook for the reinsurance industry
While the weather in Monte Carlo is set to be fair for the Rendez-Vous, the reinsurance industry faces a turbulent outlook due to climate change, worsening international relations and economic strains.
The Russia-Ukraine war has created global political and economic convulsions, threatening essential energy and food supply chains.
It has also thrown parts of the industry into confusion, with agriculture, trade credit, aviation and marine underwriters scrambling to work out their exposures.
Despite some commentators calling the conflict a systemic loss for the reinsurance market, Willis Towers Watson has reportedly estimated the loss from the war at around $15bn – the equivalent of a midsized catastrophe.
S&P Global Ratings believes that it could eat into companies’ profits but is unlikely to erode their capital. Johannes Bender, a director at S&P, says: “The Russia-Ukraine conflict is a human tragedy, but we believe it’s manageable for reinsurance companies in terms of their exposures and losses.”
The problem, according to James Vickers, chairman international, reinsurance, at Gallagher Re, is that “this loss might fall not across the wider market, in the same way as a big cat, but instead it may fall on a more limited section.”
The uncertainty of whether the conflict will create losses such as for confiscated airliners – and how big the bill might be – has prompted players to reassess the wordings in their contracts.
Over the past couple of years, “We’ve seen the emergence of two unexpected systemic risk exposures that are embedded in the products we underwrite. The scale of the COVID-19 business interruption losses was completely unanticipated. Now, the Ukraine war is creating a lot of uncertainty as to whether there are insured losses in the speciality space. Very clearly, there’s an underappreciated systemic risk potential in some areas of that marketplace,” says Mike Mitchell, Swiss Re’s head of property and speciality underwriting, reinsurance.
Reinsurers are looking to tighten up their wordings to try and eliminate any confusion. “Our clear priorities are having absolute clarity over the coverage topics in the original wordings, whether it’s embedded cyber or the quality of war-exclusionary language in our contracts,” Mitchell adds.
Rising prices equal rising risk
But the reinsurance industry is facing a sterner test than the Ukraine war. “Economic inflation is probably the biggest challenge that we face across all lines of business,” Mitchell says.
Rising prices mean rising values, which lead to more risk and, in turn, force companies to hold more capital. Although reinsurers’ capital has grown, thanks to better performance and buoyant equity markets – Gallagher Re estimates the core reinsurance industry’s capital grew by 10% in 2021 – that increase might not be enough to keep pace with rising inflation.
“Capital has increased, but given the uncertainty, particularly in the macro environment, the window of return on capital has not,” says Bertrand Romagne, CEO for international, reinsurance, at AXA XL Reinsurance. “As such, we need to service this capital while increasing profitability. The last eight years have, overall, been a mixed bag, so therefore the industry can’t be complacent. In a market like this strong discipline in underwriting needs to be exercised.”
Mitchell says: “It’s important for us to ensure that we’re fully able to assess inflationary exposure impacts on our loss exposures and then make sure that we can recover appropriate margins to compensate us for those. But also, we need to improve the returns that we’re making after we’ve risk adjusted all these exposures.”
Yet high inflation and interest rates aren’t new to the world economy or the global reinsurance market, says Vickers from Gallagher Re. “It’s long been a feature in a lot of mid-tier countries and emerging markets. Reinsurers know what to do, even though they may have not needed to apply the techniques in large mature markets in recent years, which have long enjoyed low inflation. So their managements are having to learn how to apply these tools to manage in a higher inflation environment, such as regularly updating the indexation assumptions of sums insured, keeping an eye on cedants’ deductibles and controlling the cost of claims.”
Easier said than done
Keeping a lid on claims is proving difficult, however. Supply chain disruptions are pushing up the cost of repairing everything from houses to vehicles. UK motor insurers have recently warned that the higher value of second-hand cars and the lack of spare parts are pushing claims inflation into the double digits.
Alongside this, more frequent – and more damaging – catastrophes are causing severe shortages in labour and raw materials, which are further eating into the reinsurance industry’s pockets.
“Inflation is just so pervasive. It is causing increases in losses, which we saw play out in the Australian floods in the first quarter of this year, when perils raised its loss estimate from around $4bn to nearly $5bn,” says Mitchell.
The inflation indices covering residential construction in the US “have seen greater rises and increased vulnerability” compared to the consumer price indices, explains Matt Bussmann, a senior manager with catastrophe modeller RMS. He says that “lumber prices spiked after the hurricane season in 2018, which coincided with supply constraints from Canadian suppliers. This then fell back as capacity came back online. As supply chains come back to life and energy prices look for a new equilibrium, much of this story remains to be written.”
The problem is most acute in Florida. Peter Datin, a senior director of modelling at RMS, calls the insurance market in the US state “a test bed for social inflation”.
“Homeowner insurance premiums in Florida continue to increase at a record pace, with many primary insurers seeking rate increases of up to nearly 50% this year alone,” he says.
RMS analysis of insurance claims from hurricanes Irma and Michael revealed that several factors, including social inflation, influenced the cost of repairs and high claim payouts.
In May, Florida passed new legislation aimed at helping the insurance market and homeowners after the next big storm.
“Only time can reveal the full impacts of recent legislation, but sadly another Category 1 or 2 hurricane this season may place Florida insurers under intense pressure,” says Datin.
It might take a couple of years for the impact of these legislative changes to be fully understood.
“The insurance and reinsurance industries have been crying out for these measures for some time, but they came in at the last minute, just before the 1 June renewals. That meant companies couldn’t do the kind of detailed analysis that’s required,” Vickers explains.
Bender, meanwhile, says that S&P is closely monitoring inflation and the impact on reinsurers’ claims costs and reserves, in particular on long-tail lines of business.
“We’re not overly concerned with the impact of inflation on short-tail lines of business because reinsurers can usually adjust their premiums each year – providing, of course, the overall market context allows them to increase prices,” he explains.
But there could be trouble brewing in regions that have been hit by a string of costly catastrophes, such as Florida and northern Australia.
“It’s all very well for reinsurers to say they need more money, but that then raises the question can original policyholders afford the increased premium costs insurers are passing on?” asks Vickers.
“That creates a far more serious problem in the long term if affordability issues lead to the private insurance sector reducing or ceasing to provide cover, as this will diminish the global reinsurance industry’s wider societal and economic role.”
The solution, according to Vickers? “We need to take a more nuanced approach, based on what insurers are doing to mitigate the risks in their portfolios,” he says.