Capacity holds back prices as cat losses build, says Moody’s

At its reinsurance outlook event, the ratings agency explained its recent upgrade of the sector from negative to stable. Vice president and insurance credit analyst Helena Kingsley-Tomkins said vaccine rollouts and easing of restrictions were fostering recovery across many G20 economies. That was bolstering demand for insurance and reinsurance—“particularly given the greater risk awareness brought on by the pandemic”, she added.

“This time last year when we put the outlook on negative, we didn’t have a vaccine, and market predictions suggested the pandemic could be one of the costliest insured events in history,” said Kingsley-Tomkins. Incurred losses of $37 billion were significant “but not exceptional compared to some of the largest catastrophe losses that we’ve seen over the last few decades”.

The pandemic would continue to drag on the sector’s earnings, but COVID-19-related claims were expected to continue to reduce as vaccines were rolled out globally.

Consequently, the property and casualty (P&C) market could grow 3 to 4 percent in 2021 and 2022, she said, which could boost revenues by about 10 percent on pre-pandemic levels. The agency also expects recent years’ pricing increases to continue, driven not just by demand but high cat losses.

Cats and claims inflation

Heavy cat losses over the last four years had already driven up demand and pricing, said Kingsley-Tomkins. “We think there is enough momentum for further rate rises, particularly given the significant activity that we’ve seen this year to date,” she said.

First half cat losses of around $42 billion were some of the highest on record for the period, and European floods and Hurricane Ida (looking as though it might cause losses of $40 billion) had added to this.

“It’s not inconceivable for total cat losses for the year to be around $100 billion,” she said.

Longer-term analyses suggested that environment and social factors were driving up the frequency and cost of catastrophes—particularly “unpredictable” secondary perils such as floods, storms and wildfires.

“They are difficult to predict partly because they can happen anywhere, at any time, and the losses can be heavily influenced by human behaviour; but also because traditional approaches—stochastic models based on historical data—are not as helpful,” she added.

At the same time, property cat pricing was still below 2012 levels, she added.

Added to this, re/insurers faced continuing claims inflation. That was due to recent increases in materials and labour costs, but also longer-term trends. These included social inflation, with rising litigation costs affecting the US casualty market.

While there has been a recent slowdown, Moody’s expects social inflation to begin to pick up speed again. “We did see a temporary easing, but this really was related to the pandemic lockdowns,” Kingsley-Tomkins said.

“We know that claims inflation is pushing up the pricing, but the risk is that it could start to outpace the rate increases we’re seeing.”

Holding back the tide

Several factors would be likely to limit price increases, with P&C reinsurance buyers expecting them to remain in low single-digit percentages.

One factor, according to Moody’s vice president and senior credit officer, Brandan Holmes, was reinsurance buyers.

Holmes agreed that rising frequency and unpredictability in nat cat events was challenging reinsurers, particularly around secondary perils.

“Modelling these events is more challenging. The industry is taking a lot of steps towards that and has a long history of being able to understand and model different kinds of perils, but climate change does present a particular challenge,” he said.

In trying to increase prices to compensate for the added uncertainty, reinsurers face cedants who remain doubtful. Moody’s recent survey of reinsurance buyers found a majority expected only a minor increase in nat cat risks in the next one to three years.

Almost 40 percent had no plans to increase their reinsurance to protect against either frequency or severity.

“Until the perception among the buyer community shifts a bit more, there’s a risk reinsurers will be carrying more of the uncertainty than they might want to,” said Holmes.

However, the central factor limiting price increases was reinsurance capacity—“already at a record high and starting to grow again”, according to Kingsley-Tomkins. Increasing capacity was coming from traditional reinsurance but also alternative capital.

While this might constrain price increases, it also offered opportunities for reinsurers, she said. “When we look back a few years, the growth in alternative capital was one of the main drivers of our negative outlook. As the assets under management were rising, alternative capital was clearly competing with traditional reinsurers.

“It was driving down pricing in property cat lines, and as we saw, it had a severe impact on profit margins,” she said.

However, its role had evolved, with reinsurers now using it as a form of retro protection to manage their capital and peak exposures.

“It is an opportunity for the market. While it is still a form of competition, we see more traditional reinsurers managing their own insurance-linked securities funds and third party platforms.”

It allowed reinsurers to opportunistically expand and contract capacity to grow their footprint without significantly expanding risk exposures.

“Today, reinsurers with well-established third party capital funds are some of the best positioned to take advantage of the more favourable operating environment—particularly because recent losses and expected catastrophe trends have increased the alternative capital markets’ focus on underwriting discipline,” she concluded.