What is the backdrop for insurers’ need for capital management?
Many insurers and reinsurers are experiencing reductions in capital adequacy. Capital has been declining over the past 18 months due to factors such as unrealised losses resulting from interest rate increases, equities market volatility, and increased catastrophe losses from the recent frequency of events coupled with higher reinsurance retentions.
Persistent inflation is also continuing to impact capital. Companies need to buy more cat limit for the same set of exposures as structural repairs are more expensive. Loss ratios continue to tick up, and some companies are even reporting adverse loss development, as auto and building repairs cost more than planned – both labour and materials.
Further, the past year has been a pretty challenging renewal period for a lot of insurers, with reinsurers raising rates and insurers being forced to raise retentions – a lot of firms had to increase retentions on their property cat programmes.
What this means is that, in 2023, you continue to have this frequency of small catastrophe events, where a fair amount of exposure might have been ceded to reinsurers in the past, but now those losses are being retained by insurance carriers. It all combines to put further constraints on insurers’ balance sheets and capital.
What about rating agencies? What impact do they have?
S&P, which for many insurance and reinsurance companies is currently the primary capital constraint, is changing its model. The implementation of that new model is expected before the end of the year, and notably, the new model has softened those capital requirements for many companies.
For some insurance and reinsurance companies, AM Best is likely to be the capital constraint going forward, and there will be a transition curve to ensuring companies understand how their business risks, and how their strategic decisions, impact AM Best’s capital adequacy calculation. For US P&C companies, we have seen a lot of pressure on capital adequacy and ratings.
While results have been challenging, there are some tailwinds with respect to underwriting and rate actions that most companies are taking to return to profitability – as long as they have adequate capital to lean into this market. As such, effectively managing capital through this part of the cycle is crucial.
How important is it for capital advisors to provide clients with a holistic outlook?
Holistic means understanding all available forms of capital, and it’s essential that our clients are aware of the options available to them. Companies need diversified sources of capital, and there are a number of forms of capital available to insurers and reinsurers: traditional reinsurance, structured reinsurance such as legacy reserve sales or capital relief quota share, debt, and equity to name the obvious ones.
But clients should also examine alternative risk-transfer solutions such as catastrophe bonds or parametric covers and structuring solutions such as captives and internal reinsurance vehicles to support capital optimisation.
We help clients review a wide range of capital opportunities so they can be nimble, flexible, and make better business decisions.
What impact do legacy dynamics have on capital provision?
Legacy is becoming a bit of a misnomer because the transactions now often include both discontinued lines and, for a number of companies, active lines of business as well.
In this particular area of the market, there is actually material capital coming to support these transactions, which makes for an interesting dynamic when you compare it to the rest of the reinsurance sector where capital is entering at a trickle.
Reserve transfers entail insurance organisations handing reinsurers their assets and insurance liabilities, and the asset managers aligned with the reinsurers have the opportunity to invest a bit more aggressively than an insurance company because they are regulated in a slightly different way, which is how the reinsurers make most their profit on these transactions.
How are clients responding to your advice, and are you seeing any trends in your service provision?
There’s an increasing interest in private debt deals in the United States. We’re also seeing the structured reinsurance market step up to support some of the property catastrophe retention increases we saw earlier this year, meaning that structured reinsurance, which is a small piece of the reinsurance market, will offer multi-year, multi-event type solutions, as well as capital relief quota shares and other structured quota share solutions. So, we’re seeing a part of the market gaining momentum to support some of the more challenged areas.