Beazley’s Vaughan on navigating a challenging US treaty market

Given that the reinsurance market has suffered five consecutive years of losses and failing to meet its cost of capital, you would think that investors may have begun to think twice before allocating capital to the sector.

And yet, as interest rates remain stubbornly low and investors continue to hunt for yield, the sector’s capacity has steadily grown over that period.

Even with the losses suffered over the past year, it seems that going into this 1.1 renewal season capacity will remain abundant, posing a challenge to the numerous reinsurance carriers which have publicly come out in favour of higher pricing, as risks and demand grow.

The US market is emblematic of this trend, and Beazley head of US Treaty Mark Vaughan spoke to the 1.1 Club, Intelligent Insurer’s online, on-demand platform for interviews and panel discussions with industry leaders, to discuss how the market is looking in the run up to renewals.

The counterintuitive growth of the industry’s capital base even as the losses have continued to mount poses something of a puzzle for carriers, Vaughan says.

Losses such as those faced over the past year typically translate into higher prices as some capital retreats from the industry, but Vaughan says he is shocked that the capacity remains consistent or growing despite the challenges to profitability.

“The US market is challenging. We’ve had a lot of loss activity over the last few years,” he said.

“The global treaty markets have been losing business and profit for five consecutive years, which is fairly unprecedented. In some ways it beggars belief that we’re still seeing additional capacity flowing into it. Climate change seems to play a part in much of this.”

Vaughan says that the uncertainty hanging over whether current rates are now adequate as secondary perils have grown to a larger and more prominent share of overall losses is calling into question the accuracy of firms’ modelling.

“We’re seeing in the results and uncertainty in the pricing, driven by losses from many of those secondary perils that we’ve seen in the US and worldwide—wildfires, windstorms, flood, terrorism, etc.

“We’re trying to look at the implied model return we’re seeing from a lot of these secondary events, such as wildfires, which puts a lot of those models unrealistically low.

“That means we need to adjust those models upwards to represent a better view of the reality we’re seeing from those types of events. Generally we’re trying to increase our loss picks to include that all-perils price, with definitive pricing for the less well-modelled perils,” Vaughan said.

“We need to make that price objective and for it to be an upfront conversation with clients so they can factor it into their own original pricing as well.”

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Reinsurance programmes

As important as the longer-term horizon is, in the immediate sense there is also a growing wariness among treaty providers about the strain that the reduced profitability and increased loss burden has had on primary carriers’ reinsurance programmes.

Vaughan says the lack of income on the primary side to support buying higher level reinsurance programmes meant that the market was considerably harder at the lower end of the spectrum.

“These results put additional strain on their reinsurance programmes. And that then reflects in the fact they need to buy lower level, which is probably unsustainable, but it’s having to support fairly low levels of capital, because they’re not making any income each year to add to that,” Vaughan said.

“The treaty market is becoming generally wary of some of those layers, and some of those less well-capitalised entities, which even at a high rate on line, are still sustaining too much loss activity.

“That’s creating some interesting dynamics, in that you’re getting a very hard market at the low end of programmes, or it’s forcing carriers to consolidate into larger better diversified entities, who are then able to sustain more meaningful retentions. That’s what we look for.”

As smaller, more thinly capitalised entities struggle to compete in a market of inadequate pricing, Vaughan says that as a reinsurance carrier, Beazley would rather work with more stable companies which have the scale to handle the risk on the books.

“We’d rather see stronger entities with more stable reinsurance partners. I should also say that the retention levels haven’t kept pace with the inflation we’ve seen over the last decade. They need to keep on ticking up further, which we haven’t seen.

“Some of the rating agencies have been culpable in giving overly optimistic ratings for some of those less well-capitalised entities, which doesn’t really help the overall situation,” he concluded.

To view the full 1.1 Club interview click here