New year, new challenges
Is 2023 set to be the most testing year for the industry in living memory?
Macroeconomic uncertainty, volatile market conditions, digital imperatives, and regulatory upheaval are all flashing red on CEOs’ 2023 dashboards – and feeding into business planning.
At least the underwriting cycle is responding, brought back to life by the twin paddles of supply and demand.
In a recent note, analysts at investment bank Jefferies described the industry pricing outlook as ‘astonishing’. Citing 50% rate increases expected by Beazley for property reinsurance in 2023, Jefferies saw “positive read-across for other reinsurers”, including the major European reinsurers, Hannover Re, Munich Re, SCOR and Swiss Re, as well as Lloyd’s insurers.
Meanwhile, in December, Lloyd’s said it expects to increase gross written premium volume by 14%, up from £48.9bn this year to a record £56bn in 2023, on the back of double-digit rates increases in most lines.
In the coming year, consistent, transparent, and dependable behaviour from our market will be a hot commodity
Patrick Tiernan, Lloyd’s chief of markets, said the spike will be driven by property, cyber and lines impacted by the war in Ukraine. Speaking at the market’s Q4 press call, Emma Stewart, Lloyd’s’ chief actuary, warned that while premium income would rise significantly, so would capital requirements, because of “modest” exposure growth, inflation and the strength of the US dollar.
The alternative capital markets will continue to play an important risk transfer role for the P&C reinsurance market heading into 2023, according to Mark van Zanden, head of strategy at Convex Group in Bermuda.
But the alt markets’ appetite has weakened following five years of industry wide mediocre performance: “This has inevitably led to one of the hardest P&C reinsurance and retro markets we’ve seen in recent memory," he adds. "In the coming year, consistent, transparent, and dependable behaviour from our market will be a hot commodity.”
Aon took a nuanced view in its Q3 Market Dynamics report (from mid-December) saying that [primary] conditions continued in EMEA characterized by modest price increases, generally sufficient capacity and “underwriting prudency – with a higher level of cautiousness and conservatism around cyber, US exposures and product recall”.
Overall, Aon describes the pricing environment as competitive and healthy: “Modest price increases continued, driven upward by inflation, supply chain challenges, and labour shortages, while improved insurer performance, increased capacity, and insurer focus on retention and growth had a dampening effect.”
Inflation is a big immediate concern across all developed insurance markets going into 2023. Ludovic Subran, chief economist at Allianz, said on an online panel hosted by GDV, the German insurance association, that he expects inflation to remain in double digits over the winter.
“In 2023, inflation will fall but even by year-end it will most likely still be around 3 to 4 percent”, Munich Re’s chief economist Michael Menhart added.
Jérôme Haegeli, chief economist at Swiss Re, called the current environment a “big stress test” for the global economy. According to Haegeli, the mild recession that’s in view is not even the worst thing but rather the lesser of two evils, the other one being structural stagflation, i.e. high inflation coupled with stagnant growth, which is a lot more dangerous.
In its global insurance outlook report published in December, Moody's pointed out that CPI inflation has exacerbated claims inflation, with short-tail property lines most affected. The ratings agency added the spread of claims inflation to longer-tail lines would hurt current-year underwriting profitability, which could push P&C insurers to strengthen their reserves.
Reserving and solvency will be a talking point next year across the market but especially for UK based carriers. At the same time as the EU’s European Insurance and Occupational Pensions Authority looks to fine tune the Solvency II regime after a period of consultation, the UK Government has announced plans to diverge from the bloc with its own so-called Solvency UK framework.
Part of a Big Bang 2.0 for the City of London, the new Solvency UK objectives will be welcomed by the industry going into 2023, for a number of reasons. First, it should be easier to raise capital and enable insurers to use more of their capital as investments. It will, in theory, also facilitate new entries in the market – both products and providers.
Importantly, there’s no radical reform of the fundamental spread as originally set by EIOPA, and designed to protect firms against credit risk by requiring a minimum capital reserve.
In a step intended to make the UK (and the London market) more attractive to foreign businesses, UK branch capital requirements will be removed provided the parent company is sufficiently capitalised.
In addition, the thresholds for the size and complexity of insurers before Solvency UK applies is to be increased to £15 million in annual gross written premiums (three times the previous threshold) and £50 million in gross technical provisions (twice the previous threshold).
Barry O’Dwyer, ABI president and Royal London Group CEO, welcomed the changes, saying he welcomed the proposed reduction to the risk margin by 65% for life insurers and 30% for non-life insurers. “We are pleased to see proposals to broaden the asset and liability eligibility criteria for the matching adjustment. This would allow industry to invest in a wider array of assets and also enable relevant insurers to include morbidity liabilities in matching adjustment portfolios,” he added.
London Market Association CEO Sheila Cameron added a note of caution, however. “We do not want to see the UK regime diverge too far from recognised Solvency II or similar regimes around the world,” she told Insider Engage. “Tweaks to capital requirements that promote investment are welcome but maintaining equivalence will also be vital to maintaining market competitiveness.”
New thinking around capital and solvency could spur M&A activity in 2023, according to Tony Ursano, founding partner of Insurance Advisory Partners in New York. He believes that scale continues to be an important ingredient to success because carriers need to invest in technology, grapple with volatility and deal with regulatory and rating agency demands. “The large players are best positioned [in this market environment], while certain small and mid-tier companies will continue to struggle to make the return on capital that their shareholders can reward with a respectable valuation,” he told Insider Engage.
...we have seen a peak in valuations in both the public and private markets
In the insurance distribution and services segment he says that there is an appetite for cashflow businesses that are not capital intensive and that have a steady, consistent cashflow profile. “But there is a correction coming in terms of valuations. There is an increase in the cost of debt and it’s a business [model] that for the most part has been optimised from a margin perspective. It will be difficult to optimise EBITDA margins substantially more.
“Last, there’s a huge supply of PE owned businesses where it’s not a question of if they will be sold but when they will be sold. So, there will continue to be [M&A] activity because there is substantial strategic and financial investor appetite. But we have seen a peak in valuations in both the public and private markets.”
Overall, Ursano is bullish about M&A across the carrier, insurance services and insurtech sectors: “As visibility improves as to when interest rates will peak it will create an environment where people feel much more comfortable and convenient transacting. That will further accelerate activity.”
Against a background of interconnected market and structural challenges, the industry has to stay focussed on remaining relevant, according to Convex’s Mark van Zanden: “Primarily, we need to seriously consider how we as carriers can get closer to our clients and gain a deeper understanding of their business needs, to develop value-adding solutions at fair and sustainable prices while also providing the insights that will help clients navigate changing landscapes,” he told Insider Engage.
“We also need to be proactive in our thinking. How can we assist our clients and position them to be on the front foot with respect to factors such as ESG, climate transition and deteriorating social cohesion?”
Industry players should examine their own management culture and how they are supporting the mental health of employees, he adds: “Now is the time for companies to stand up and help their staff. Factors such as D&I, staff wellbeing and the challenges faced at home are all vital in a business’s resilience, growth and success - and a key consideration for any carrier when assessing a client’s risk.”