Reinsurers risk misunderstanding secondary perils due to cat models

The growing prominence of loss events arising from secondary perils could cause reinsurers to “misunderstand or underprice” their exposure because models for these risks are less developed compared to primary peril modelling, according to Jim Bichard, partner and global insurance leader at professional services firm PricewaterhouseCoopers (PWC).

Speaking exclusively to Global Reinsurance at this month’s Rendez-Vous de Septembre conference in Monte Carlo, Bichard explained that the previously clear-cut boundary between primary and secondary perils is fast becoming more blurred as an increasing number of losses are attributed to secondary perils, rather than primary ones.

According to a 2019 publication from Swiss Re, primary perils are typically defined as having the highest loss potential, are well monitored and are usually covered by catastrophe models.

Secondary perils, meanwhile, traditionally generate small to medium losses and are caused by events such as hail, storms and bushfires. Swiss Re added that these risks often have less mature modelling capabilities.

Bichard explained that secondary perils may no longer be “quite the right tag” for these types of weather events because it appears that “most of the losses are coming from” these incidents, rather than primary perils.

He believes secondary perils “has gone away as a concept”.

He continued: “We’re seeing more and more losses for the whole year come from areas which traditionally were the less busy, less dramatic areas - like wildfires.

“You’ve got Australian storm events, you’ve had California wildfires, you’ve had European wildfires and European storms, all of which has added up before you even get into the traditional hurricane season.

“It used to be [that] there wasn’t a lot of exposure to Europe and then you’d just be waiting to see if it was a busy Florida [in terms of hurricanes]. There are losses throughout the year you can be exposed to [now].”

Lack of data?

The problem with this peril pivot is that “secondary perils are much less well modelled – there’s just much less data on them”, Bichard noted.

Therefore, reinsurers could “misunderstand or underprice the exposure” they have to these types of events.

He explained: “We’ve got a lot of catastrophe models on Florida that are very well established, even though inflation is a factor. But comparative to that, our knowledge of other windstorms and freak weather events is much less deep. Do we have a model for how drought impacts supply chain, [for example]?”

An expensive year ahead

Secondary perils have caused reinsurance losses in the first half of the year to be unusually high, Bichard added.

This combination of “climate impacted losses” and “inflation on top of that” means it is “going to be a pretty expensive year” for the reinsurance sector – this has subsequently led to “momentum” around “price hardening”, he said.

Underwriters have therefore “got the ability to really be quite strict on terms and conditions and pricing”, Bichard continued, because “now is the time when they can ask for whatever price they want”.

“There’s more demand than capacity, so you’ve got a lot of insurers wanting to offload more catastrophe risk and so the reinsurers can be a lot more selective about which risks they [take on] and, therefore, maintain their terms. Everything I’m hearing is that their discipline is pretty strong,” he said.

In terms of mitigating inflation, reinsurers’ “major lever” is pricing – especially on short tail lines that can be repriced quickly ahead of 1/1 renewals.

However, “the tricky thing is when you’ve got historical inflation which comes through two or three years later – it’s way too late to [then] try and reprice”, Bichard continued. This is often the case for “problematic” casualty lines, he added.