Why did the 2017 cat season not turn the market?

22 October 2018

David Flandro, Global Head of Analytics, JLT Re
Julian Alovisi, Head of Research, JLT Re

Following five consecutive years of falling rates, there was much speculation about how the market would react to 2017’s hurricanes, wildfires and earthquakes. To the surprise of some, the market responded with liquidity and stability. 

Capital

There was no repeat of the price hikes that followed previous large-loss years such as 2005, which included hurricanes Katrina, Rita and Wilma (KRW).

Figures 1 and 2 show why KRW turned the property market while the losses of 2017 merely brought about moderate rate firming.

Figure 1

cat risk

Figure 2

cat risk

Although insured catastrophe losses were similar in both years, the effect on sector capital was far less in 2017 with only three (re)insurers losing a quarter or more of shareholders’ equity compared with at least 18 carriers in 2005.

Twelve of these eventually ceased trading as a direct or indirect result of 2005’s losses, something which is unthinkable in today’s market.

 

Why the vast difference between two similar large loss years?

First and foremost, traditional reinsurers faced 2017’s losses from a position of clear capital strength. 

Adding to this was US$75 to US$80 billion of third-party capital on the sector’s balance sheet prior to the losses, most of which had entered the market in the previous five years.

It is not surprising that 2017 was the first time third party-backed vehicles absorbed losses in the double-digits of billions.

These factors, combined with increased reinsurer diversification, made 2017’s record losses an earnings event, not a balance sheet event.

And sector capital has been in a continuous process of replenishment starting with the kick-off of 2017’s renewal season – before hurricane season had finished – driven in no small part by new capital entry.

As at the first half of 2018, dedicated reinsurance capital has returned to record levels.  Dedicated sector capital, then, clearly goes a long way in explaining the muted pricing reaction to 2017’s losses.

It is nevertheless important to remember that capital supply and industry losses are not the sole factors driving pricing. For example, analysis by JLT Re shows that the nature of losses can magnify or mitigate demand for cover. ‘Surprise’ factors in particular can magnify subsequent price movements. 

The cycle is not dead

2017 marks, in the view of some, the end of reinsurance rate volatility, and a flatter underwriting cycle does look likely in the near-term. But a true ‘shock’ event that challenges underwriting assumptions and significantly impairs capital could still alter both supply and demand.

And it is crucial to remember that the industry’s balance has not been driven over the long term by catastrophe losses, but by reserving movements and asset volatility. Both of these are affected by inflation, the interest rate cycle, and ultimately by macroeconomic growth trends.

1 JLT Re Viewpoint Rethinking the Reinsurance Cycle


David Flandro
+44 (0)20 7466 1311
david.flandro@jltre.com

Julian Alovisi
+44 (0)20 7558 3376
julian.alovisi@jltre.com