Why 2019 looks promising for reinsurers

Global insured losses from catastrophes in 2018 are estimated to be $79 billion, the fourth highest on sigma records and higher than the annual average of the previous 10 years, according to preliminary sigma estimates by Swiss Re.

Examples of 2018's devastating natural catastrophe events include hurricanes Michael and Florence; typhoons Jebi, Trami and Mangkhut; heat waves, droughts and wildfires in Europe and California; winter and thunderstorms around the world; floods in Japan and India; earthquakes in Japan, Indonesia and Papa New Guinea; and volcano eruptions in Hawaii.

Total economic losses from natural and man-made disasters in 2018 are estimated to be $155 billion, down from $350 billion in 2017, according to sigma data.

Global insured losses from disaster events in 2017 were $144 billion, the highest ever on Swiss Re’s sigma records.

The biggest losses in 2017 came from three hurricanes – Harvey, Irma and Maria (HIM) – that struck the US and the Caribbean in quick succession.

Moody’s believes that the significant insured catastrophe losses incurred during the past two years, which are estimated to be in excess of $200 billion, with $50 billion to $70 billion occurring in 2018, provide support for stable to higher pricing levels into 2019. The catastrophe losses have also provided support for stable to rising rates in casualty reinsurance along with lower ceding commissions, the agency noted in a December 18 report.

Rates on the rise

Market participants are indeed expecting steadily rising reinsurance pricing over the course of 2019, according to Keefe, Bruyette & Woods (KBW) analysts.

The hardening conditions reflect declining supply and an expected rise in demand, which could extend into other lines, particularly the retro-dependent Lloyd’s market, KBW said in a Dec. 19 analyst note.

In its annual renewal report, Guy Carpenter said potential sector pressure from global catastrophe losses in the second half of 2018 and the continued development of 2017 claims was at least partially offset by plentiful capacity. As a result, its Global Rate on Line (RoL) Index, a measure of change in catastrophe premium dollars paid year on year, increased just 1.1 percent despite back-to-back years of major loss accumulation, the broker noted.

The January renewals largely comprise European and national US accounts with few or manageable 2018 catastrophe losses, and many January reinsurance renewal quotes were issued in November, preceding both the California wildfire losses and Markel CATCo’s disclosed regulatory inquiries, KBW analysts noted.

Reinsurers expect 10 percent+ pricing for mid-year renewals, Morgan Stanley said in a December 19 research note as industry participants are more optimistic as 2019 progresses. Market participants expect 10 percent+ rate increases at April 1 Japanese wind renewals and potentially even higher at June 1 Florida renewals, according to the investment bank. The driving factors are rising retro costs and large losses from both recent events and adverse development in 2017 losses, analysts said. Alternative capital has been a key pressure point for reinsurance pricing in the last 5-10 years but higher perceived natural catastrophe risks (especially California wildfires) and heightened regulatory scrutiny (related to CATCo investigations) could dampen third party investor interest, Morgan Stanley noted.

“We think alternative capital is here to stay but its rapid growth could take a pause as investors are reassessing the risk reward given recent developments,” the analysts said. “We note that market dynamics could change between January 1 and mid-year renewals. The disappointing renewals in 2018 is a reminder,” they said.

Retro pricing reacts

Retrocession pricing is definitely “tighter” and KBW believes there’s a very wide retro rate increase range that could average out at around +15-20 percent, but little retro had been bound as of end of December 2018, particularly for loss-impacted accounts, analysts noted.

Retro capacity has been hit by losses and collateral has been trapped by late events like the California wildfires. Cedants are increasingly reluctant to release capital prematurely and some significant insurance-linked securities (ILS) fund redemptions are – unlike in 2018 – not being replaced by newly raised funds. ILS funds represent an estimated 75 percent of global retro limit, KBW noted.

Moody's was expectng retrocession pricing to see potentially significant price increases at 1 January 2019 as recent catastrophe events trapped collateral, according to a December 18 report.

Losses late in the year from hurricane Michael and the California wildfires have “trapped” the collateral of a significant portion of total retrocessional capacity deployed during 2018 and resulted in a late renewal season, Moody’s said.

The degree to which this anticipated price-hardening spills over to the broader reinsurance market will depend on how the ILS market responds to two years of poor underwriting results that for some funds have wiped out years of gains, Moody’s said.

ILS: opportunity and threat

Some market participants believe there could be some withdrawal of investor capacity that drives pricing higher, the agency noted. Others believe ILS investors will retain a “business as usual” perspective and provide sufficient capacity into the market that keeps a lid on price increases, Moody’s said.

Most reinsurance executives KBW spoke to were therefore cautiously optimistic about the later 2019 renewal dates. Both Japanese renewals (typically at April 1) and Florida/Southeastern US renewals should include a higher percentage of loss-impacted accounts reflecting typhoon Jebi, hurricanes Florence and Michael, and numerous other smaller events, analysts noted. ILS capacity deployed to Japan is expected to remain low due to ILS fund redemptions, trapped capital, and still-growing losses from hurricane Irma and a similar risk for hurricane Michael and the California wildfires, the report said.

In December 2018, AM Best has revised its outlook for the global nonlife reinsurance segment to stable from negative, driven by a “growing alignment between traditional and third-party capital among non-life reinsurers”.

“A more-stabilized pricing environment—albeit at levels still below long-term adequacy—a rising interest rate environment, emerging growth opportunities and ongoing stability in the global life reinsurance segment also are factors in the outlook revision,” AM Best said.

The latest Best’s Market Segment Report, titled, “Market Segment Outlook: Global Reinsurance,” states that excess capital in the non-life reinsurance market has provided companies the ability to take advantage of market opportunities and offer new products, invest in innovation and pursue mergers and acquisitions (M&A). However, the excess capital continues to exert pressure on risk pricing and poses a drag on equity returns, the agency noted.

KBW agreed by saying that the biggest risk to progressively stronger reinsurance rate increases is the potential for increased capacity, including ILS fund inflows, and there are definitely some examples of current fundraising. Stephen Catlin is, for example, reportedly progressing toward raising about $3 billion to establish a new reinsurer, analysts noted.

Hamilton is looking for ILS investors, and RenaissanceRe just announced a $600 million - $1 billion joint venture targeting very high-layer North American catastrophe risk currently underwritten by a small number of highly rated reinsurers.

KBW noted that many ILS investors were disappointed by both the size of actual 2018 rate increases and by actual 2018 catastrophe losses, and that overall negotiations for ILS funds are slower than in the past. Analysts expect reinsurance rates to rise at the later renewals, but they don’t view potential capital raises as a dismissable or remote risk.

At the same time, AM Best noted that reinsurers that welcome alternative capital will thereby enhance their relevance with clients and investors and garner the ability to earn low-risk, fee-based income in the process.

Other factors that are driving the outlook revision include the fact that AM Best believes alternative third-party capital will hold the line on future return expectations following the catastrophe losses incurred in 2017 and 2018, although users of this capacity require more stringent credit governance over the level and release of collateral-backing loss payment obligations.

In addition, capital consumption and earnings volatility caused by tail events has declined, due in part to the increased utilization of third-party capital in retro-programmes and the growing alignment between traditional and third-party capital, AM Best noted.

Furthermore, the rising interest rate environment could lead to alternative investment opportunities for third-party capital. Rising interest rates could cause mark-to-market losses for bond portfolios, but reinsurers could benefit from higher yields if they manage their duration profiles prudently, the agency said.

AM Best also noted that there is a renewed emphasis on underwriting discipline driven by potential loss cost inflation, coupled with lower loss reserve redundancies, representing another positive development for 2019.