Will this ‘circuit breaker’ market win back capital?

You would be hard pushed to find anyone in property catastrophe reinsurance who wouldn’t agree that it’s been a tough few years in the sector, particularly in the US.

Natural catastrophes have had a significant impact and, according to PCS, over the past 30 years, there has been an estimated $830 billion in insured losses, 36% of which have occurred in the past 5 years.   

Understandably, as a result, investors have lost their appetite for injecting capital and so there has just not been enough capacity to underwrite the risk with demand out-stripping supply.

It’s been a vicious cycle: increasingly costly catastrophic risks need to be underwritten but reinsurers are struggling to meet their clients’ needs due to a lack of investor funds.

In all, this cycle has meant that reinsurers have been under increasing strain resulting in an estimated shortfall in limit of between $20 billion-$50 billion.  

Green shoots appearing

Despite the well-documented “fear” in the investment community and concerns over volatility and climate change, we are beginning to see some shoots of optimism emerge, an indication that the situation may be changing for the better. 

Why? Well, if you do the same thing over and over, you get the same outcome or results. Over the past few years, reinsurers have been promising higher prices and more restrictive cover in order to attract investment, but they haven’t delivered. 

Instead, the rhetoric around reinsurance and natural catastrophes has been increasingly negative, premiums have changed (but not by nearly enough), and structures were left largely unaltered. Investor confidence fell as a result. 

But, a perfect storm of events in 2022 (the Russian invasion of Ukraine, Hurricane Ian, rising inflation and investment losses from increasing interest rates, and challenging energy prices) finally resulted in reinsurers delivering much needed strong resolve.

Toughest market since Andrew

The recent 1 January 2023 US renewal season saw reinsurers charge a significantly higher price that was commensurate with the risk that they were willing to cover. 

According to Howden, prices were up (on average) by a minimum of 37%, the biggest year-on-year 1st January increase since 1992.

For the first time in many years, we saw pricing that was durable. I was underwriting in Lloyd’s in the post-Andrew period and that was the hardest market I thought I would ever see. 2023 is proving me wrong. 

This was the circuit breaker. As a result of reinsurers collectively putting up their prices as well as restricting cover, we have seen some investor optimism in reinsurance start to return which is incredibly encouraging for the sector and most welcome. 

The supply and demand issues of recent years have been frustrating for underwriters, brokers, reinsurers and MGAs - we now need to maintain the momentum and build on this positive start to the year if we are to come anywhere near close to providing a fit for purpose property catastrophe reinsurance market that makes superior returns for those investing in it. 

Maintaining momentum

So, what steps are needed to keep up this momentum, attract investors and maintain a strong financial position in 2023?   

1. Realistic pricing models allied to judicious client selection – insurance companies need to demonstrate  a robust financial position, together with strong underwriting & claims management. Client differentiation needs to happen not just be talked about. There will be winners & losers..   

2. Demonstrate robust underwriting skills: whilst important, price is not the only aspect of risk we should focus on  -  underwriters need to tighten terms & conditions and restrict coverage to those perils they can quantify and charge a commensurate rate for.  This should lead to more profitable portfolios of business, which will help attract investors looking for acceptable returns. 

3. Adopt smart technologies: science can never replace the art of underwriting, but a blend of those fundamentals, including smart technologies that deliver real time data on risks, can help with our analysis of risk and inform our underwriting. This is becoming increasingly important. 

4. Focus on niche markets: we will see reinsurers increasingly specialising in a particular type of coverage or market to limit their exposure and also carve a niche for themselves in the industry.  This may lead to them using MGAs in order to access specialist underwriters who can underwrite risks more profitably. 

5. Diversification: on the flip side, some reinsurers might choose to spread their risk by diversifying their offering.  Again, MGAs will become increasingly important in helping reinsurers to do this as some, including K2 CAT, provide all the underwriting experience and operational services you would expect from a reinsurer, apart from the balance sheet. 

7. Develop and issue new insurance-linked securities: according to Aon Reinsurance Solutions, insurance-linked securities are “poised for strong market growth” in 2023 due to the increase in reinsurance pricing in 2022 / 2023.  This may help to provide some of the capacity that the market needs. 

8. Some kind weather always helps, too ! 

This isn’t an overnight fix, or even a 2023 fix, but I definitely believe that, if the sector continues to adopt re-calibrated  pricing models and drive a positive narrative around investing in reinsurance, we will start to see those green shoots take hold and we may be looking at a significantly different reinsurance environment in five years’ time. 

Reinsurers cannot predict the frequency or size of natural catastrophes but, with the benefit of experience, smart technologies and industry data, we can at least charge a price that is commensurate to the risk we are willing to take, in order to help guarantee long-term future investment in the reinsurance market. 

David Carson is head underwriter, K2 CAT