Traditional Reinsurance pricing cycle redefined by structural market change says JLT Re
10 September 2018
Excess sector capital has been, and remains, the dominant reinsurance pricing driver
Muted post-HIM pricing reaction is therefore not as surprising as it may first appear
A ‘shock’ loss or macroeconomic event that precipitates the withdrawal of capital could still turn today’s supply-demand imbalance
JLT Re, the global provider of reinsurance broking and consultancy, has today launched a new Viewpoint Report – Rethinking the reinsurance cycle. Vigorous debate about market cycles and the viability of traditional business models has increased since HIM (hurricanes Harvey, Irma and Maria) made landfall last year. Whilst large-loss years in the past brought about significant and sustained reinsurance rate increases, particularly in the property-catastrophe market, this did not happen throughout 2018’s major renewals. The paper examines the reasons behind this outcome and considers why reactions in 2018 have been different to those in previous post-catastrophe loss markets.
According to the analysis, the amount of excess capital in the reinsurance sector has had more bearing on pricing than any other factor (see Figure 1). David Flandro, Global Head of Analytics, JLT Re, said, “This graphic shows the strong historical inverse correlation between the sector’s excess capital ratio and property-catastrophe pricing. During years of constrained dedicated reinsurance capital, considerable pricing pressures have built, whereas supply and demand dynamics tend to cause price declines during periods of significant excess capital. Loss activity is, of course, another crucial factor, although it can be argued that better informed catastrophe risk modelling has, for now, moderated the massive, post-event price swings which were previously common for perils such as North Atlantic hurricanes.”
Figure 1: Property-Catastrophe Pricing Versus Reinsurance Excess Capital (Source: JLT Re)
Whilst many market participants expected prices to rise significantly after the events of 2017, especially following five years of decreases, JLT Re’s analysis shows that, rather than the cost of claims, it is the nature of the losses, and the capital buffer available to absorb them, that typically determines the market response.
Ed Hochberg, Chief Executive Officer, JLT Re in North America, says “This goes a long way to explaining the comparatively muted market reaction to the catastrophes of 2017. After years of rapid capital growth, carriers confronted these losses from a position of record capital strength, meaning losses in 2017 mostly hit earnings (unlike in previous large-loss years). And the ability of capital markets to reload quickly and smoothly after HIM confirms a structural change in how capital is provided to the reinsurance market, with third-party capital entering the sector post-loss to fill gaps more or less immediately (see Figure 2). Much of this capacity has been deployed at low rates of return by historical standards, particularly in areas where insurance-linked securities (ILS) markets are most active, such as Florida. The lack of significant adverse development associated with HIM, and limited loss experience so far in 2018, have combined to reinforce the situation.”
Figure 2: Selection of Announced New Reinsurance Capital – October 2017 to August 2018 (Source: JLT Re)
But this is not to say market conditions will remain the same forever. The sector has been through periods of structural change before and has nevertheless remained cyclical. Whilst the potential for a flatter underwriting cycle is clear, a shock event that results in significant risk recalibrations could still fundamentally change market conditions. This is not without precedent, and it applies equally to potential macroeconomic changes: a pertinent point as the economic cycle shows signs of shifting for the first time since the global financial crisis. The spectre of more volatile movements for inflation and interest rates creates the potential for negative balance sheet impacts.
Keith Harrison, CEO of UK & Europe, JLT Re, concludes, “As attention begins to focus on 2019 renewals, the outlook is positive for reinsurance buyers. As our report shows, any future market turn is likely to come about only if capital withdraws, and no such development is likely in the short term. Strong competition continues to ensure capacity is competitively priced in most lines of business and regions. Equally important is the value and efficiency of reinsurance protection being demonstrated by allowing cedents to react speedily to underwriting opportunities. JLT Re looks forward to assisting clients in this process.”
1. Calculated by JLT Re using its proprietary dedicated reinsurance capital and premiums data.
2. Rate-on-line (ROL) changes shown for 1 June in Figure 1 are for the following year, apart for 2011 where the same year has been used to account for major losses occurring before the renewal took place (e.g. Tohoku and Christchurch earthquakes).
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NOTES TO EDITORS:
JLT Re Viewpoint is JLT Re’s regular series of reports that comment on or give insight into key topics, occurrences or changes in the (re)insurance and broking marketplace.
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JLT Re Viewpoint: Rethinking the reinsurance cycle