Reinsurance demand-supply balance on the line – IQUW

The reinsurance sector is reaping the benefits of recent treaty adjustments and positive rate increases that have followed a significant soft market for many years.

After reinsurers suffered multiple challenging losses, a re-evaluation of coverage, attachment points and rate increases has propelled reinsurance returns into the mid-20s in 2023 and have made for a more orderly renewal period in 2024.

With the sector’s recovery, reinsurance capital has reached record levels in 2024, rising ~20% from the lower capitalisation of year end 2022. In addition, AM Best has revised their reinsurance sector outlook to positive. Good news for the industry.

Retained earnings and asset valuation improvements have been major factors in the capital uplift over the last year or so. However, broker talk of supply and demand being in perfect harmony overlooks a lingering reticence among many reinsurance capital providers and investors about the industry, even as we experience the most favourable property market conditions in almost two decades.

Headline figures claiming ample capacity meeting the increased demand due to successive years of higher inflation are good news for the industry. However, the market had a nervous few weeks during the end of May as June 1 renewals were being finalised after forecasts of an above-active hurricane season, which abruptly squeezed property cat supply.

In addition, there have been no new (re)insurance startups attracting capital to the industry at this point. Investors likely remain concerned about the start of the hurricane season after Beryl’s unprecedented early arrival as a category five event.

Further, there are continued concerns about the mounting loss development in the casualty sector, super-sized jury awards and high ceding commissions that don’t reflect the reality of potential loss costs.

Reinsurers (and Lloyd’s) have led the P&C industry out of the earnings doldrums and the positive higher interest environment has made the sector relatively more attractive for capital providers.

However, investors are still looking for a three-to-five-year track record of strong results. Insurance stocks on the S&P 500 have outperformed the wider index for many months, but in recent weeks their lead has narrowed.

From the supply side, the hurricane season will obviously have a major impact on 2024 profitability and sentiment around the 2025 renewals, for listed entities and backers of private reinsurers alike.

Depending on the type of loss, heavy second half property cat losses, coming after Gallagher Re put first half losses 25% above the 10-year average at $61bn, might lead to further rate hardening at the upcoming 2025 renewals.

On the demand side, primary carriers have been required to retain more exposure through reinsurers’ treaty realignment, including increasingly frequent and severe losses from weather events.

However, this has had a significant impact on their insurance businesses. We’re already seeing these increased losses eroding insurers’ surplus in some regions, while stringent state regulations typically do not allow a quick adjustment to increased deductibles or rate changes fast enough to counter this financial impact.

In addition, while inflation may have eased, the impact of elevated prices for goods and services endures, and primary carriers will need additional protection to cover the higher asset values they are insuring.

What’s more, a steady parade of property events, casualty reserve increases along with specialty losses, such as the Dali/Baltimore Bridge and the CrowdStrike outage, together with continued geopolitical tensions, will add to unease about shouldering ever more risk.

That being said, if the second half of 2024 has lower than expected losses from natural catastrophes and other man made events, the industry might be awash with capital from retained earnings and returns might be more challenging in the future.

Reinsurance investors have acquired a taste for double-digit returns. Aon reported that reinsurer returns on equity in the mid-20s continued in the first quarter of 2024. Anything that abruptly jeopardises those returns will highlight how very fragile the perceived demand-supply balance actually is.