What a turn in the US reinsurance market would mean for rates in the short and long term, and how insurers should respond.
The question of whether we have hit the bottom of the (re)insurance market has been debated for some years now. The answer always seems to be the same: not yet.
But in the last 15 months, there has been a change: the softening is slowing. The bottom has yet to be reached, but it is approaching, according to market observers. Rates are still decreasing but at a slower rate.
The cycle continues
Given recent capital inflows and improved analytical capabilities, there is inevitably talk of whether the insurance cycle is dead. Would a catastrophic event change the market, or are those days over?
Ed Hochberg, CEO at JLT Re North America, is adamant the old days aren’t gone. “It is still a cyclical business – it is still an industry where pricing equilibrium is a fleeting thing – it is either a time of excess capacity or excess demand,” he says.
“It has been this way for years and I don’t see anything that fundamentally changes that. The amplitude of those cycles is likely to be different and less extreme, in part because of increased access to information, enterprise risk management, modelling and analytics and the ability of capital to flow freely.
“These will affect the amplitude of the cycles but not fundamentally change whether we have a cyclical business.”
For property-catastrophe business a series of large catastrophes within a year or multiple events over multiple years might possibly cause rates to harden, says Bob Betz, Executive Vice-President at JLT Re North America.
“If such events occur, the question is how will third-party capital react? If rates do harden following losses, will third-party capital look to take some of the upside of the rate curve?
“There was some evidence at the 1 June 2016 renewal that third-party capital would not support lower pricing in some layers. That reinforced our view that pricing is near or at the bottom of programmes,” Betz says.
JLT Re reviews the metrics on various programmes that it places. Commenting on these reviews for mid-year 2016 placements, Betz says: “We are not seeing wholesale pricing reductions but rather layer-specific pricing reductions. We expect this trend to continue if there is no significant storm activity.”
Interestingly, JLT Re is seeing a slowing of new capital coming into the reinsurance sector, driven largely by the softening of pricing, notes Betz.
What might cause the market to harden fundamentally?
A large catastrophe event within the range of modelled expected loss probabilities may cause short-term hardening but not a lengthy sustained hard market across multiple lines of business, Hochberg says.
“You have to have capital withdrawn from the market. That can happen in a number of different ways – it could be a catastrophe event, but the capital would be replaced fairly quickly. There is a lot of capital that flows freely and sits on the sidelines waiting for an opportunity to be deployed,” he says.
For a more long-term impact, reserves need to be affected as there is a clear correlation between pricing levels and accident year reserve adequacy, Hochberg says. And reserves are currently being released faster than accident year experience would dictate.
Another longer-lasting effect could also be caused by an event that causes a ‘recalibration of risk’: something truly unexpected that causes the perception of excess capital to be changed.
“If you change the equation for how much capital you effectively need, it can change the supply and demand balance quite significantly,” says Hochberg. “We saw this after Hurricane Katrina, where the rating agencies changed the game in terms of what reinsurers can do and the way they can think about their capacity.”
As to when the market may harden, particularly in light of the reserving situation, Hochberg says: “I’ve stopped trying to predict when this will happen, but clearly we are getting closer to it.”
The market is currently still soft, which makes it all the more surprising that demand has been falling in recent years. “Reinsurance in many respects has never been a better deal,” says Hochberg.
“When you think of where pricing levels are now relative to where they have been, as well as the financial strength of the counterparties, the value proposition of the product has never been better.
“Companies are now looking at this and asking ‘Why am I keeping all this risk on my balance sheet when I can transfer it at a reasonable cost with very strong counterparties?’ We have seen it in 2016 and I would expect to see more of it in 2017.”
This is the time for buyers to review strategies and relative costs of capital, says David Flandro, Global Head of Analytics, JLT Re. “The burgeoning increase in demand will create important opportunities for insurers and reinsurers, alike.
“Today’s current environment of abundant capacity, coupled with a renewed focus on innovation, provides an opportunity for carriers to make genuine strides in creating new solutions for underinsured risks.
“This could include comprehensive flood and terrorism coverage, and the development of cover for relatively new risks such as cyber, reputational, supply chain, fourth generation nuclear and autonomous vehicles to name a few.”
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