AIG and other insurers avoided steep losses from a spate of extreme weather this year thanks in part to the reinsurance industry. But increased reliance on those policies probably means price hikes are coming.

 “This year we’re seeing good demand and good price increases for reinsurance, and I think that just keeps happening,” Matthew Palazola, an analyst with Bloomberg Intelligence, said in an interview.

Disaster costs this year are approaching $300 billion, and insurers are expected to foot the bill for more than $100 billion of those losses, according to data from Aon. AIG Chief Executive Officer Peter Zaffino this month pegged global third-quarter catastrophe losses at $45 billion to $55 billion.

Paying those bills was easier because of coverage from reinsurers – the firms that backstop risks for insurance companies – helping AIG and its peers power through the catastrophe-heavy third quarter and still report a profit. It’s likely the industry’s reliance on reinsurance will increase as extreme weather becomes more common.

“If climate change has a truly material impact on the volatility of these events and the size of these events, then reinsurance becomes more and more important,” J. Paul Newsome, an analyst with Piper Sandler Cos., said in an interview.

Greater Severity

The insurance industry is set to surpass $100 billion in losses in 2021 for the fourth time in five years, according to Aon, and company executives have pointed to rising global temperatures and ensuing extreme weather as key culprits.

“We’ve never seen consistent CAT losses at this level,” AIG’s Zaffino said on a conference call with analysts earlier this month, referring to catastrophe losses. The industry needs “to acknowledge that frequency and severity has changed dramatically as a result of climate change and other factors.”

It’s too early to say exactly how much reinsurers are on the hook for when it comes to Hurricane Ida and other third-quarter natural disasters, according to Tom Johansmeyer, who heads Verisk Analytics Inc.’s property-claim services division. The process typically takes many months, he said.

But it’s clear those disasters battered reinsurers. The property-casualty reinsurance business at Warren Buffett’s Berkshire Hathaway Inc. posted an underwriting loss of $247 million in the third quarter, compared to a profit of $99 million during the same period a year earlier. Berkshire attributed some of the reversal to “significant catastrophe events,” including Hurricane Ida.

As reinsurers grapple with more destructive natural disasters, as well as inflation in the cost of construction materials, higher premiums can’t be far behind. Another possible option is fine-tuning the models they rely on to better grasp their exposure.

“It all comes down to pricing the risks appropriately,” said Karen Clark, CEO and co-founder of risk modeler Karen Clark & Co. The firm estimated in a white paper this month that average annual hurricane wind losses could increase 10% to 19% by 2050 as climate change strengthens storms.

Outside Capital

While steeper losses mean higher prices, there is one encouraging development for the reinsurance industry: Financing has become easier to secure.

“The path for capital to get to the reinsurance market has been well-paved,” Palazola at Bloomberg Intelligence said. “You can participate in this market a lot more ways.”

Rates in the sector are becoming particularly attractive for outside sources of capital, and that could help to keep prices down, Palazola said.

At the same time, higher reinsurance rates could bode well for hedge funds and pensions that seek out tangential investments such as catastrophe bonds. Pricing for those securities often mimic reinsurance rates, since both markets rely on modeled natural-disaster losses.

And it’s been a booming market, with $13 billion of bonds issued in the 12 months through June 30, $4 billion more than a year earlier, according to data from Aon. More broadly, capital tied to insurance-linked securities increased to $97 billion from $91 billion.

For their part, reinsurers see an opportunity to tackle one of the vexing issues facing the global financial system and society more broadly.

“Due to our industry’s holistic view of the risk chain, we are uniquely positioned to understand the systemic risks of climate change, and deploy the capital needed to better protect people in the face of extreme events,” RenaissanceRe Holdings Ltd. Group Chief Risk Officer Ian Branagan said in a statement.

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