Heavy losses from secondary perils prompt a return to traditional underwriting: ILS Capital

The heavy losses the industry has borne in the past two years caused by so-called secondary perils have forced something of a reset in the mentality of re/insurers, whereby some are relying less on the pure output from risk models and more on their own individual view of the risk before them.

That is according to Glenn Clinton, managing director, ILS Capital Management, who told APCIA Today that the often unexpected losses have in part prompted a move back towards what he calls traditional underwriting.

“Reinsurers are increasingly taking the models and working more intensely with their outputs to ensure they represent a true reflection of the risk they are taking on—and the price they are getting for it,” Clinton said.

“It is a return to a more instinctive nuanced approach to underwriting based on experience and judgement rather than only the result of a model. For too long, the industry has become used to relying on the models as the ‘homework’ answer.

“While they do some things well—such as assessing the risk of primary perils—they are not so good at other things, including secondary perils.”

By Swiss Re’s calculation, in 2018 global insured losses from secondary perils exceeded those of primary perils for the first time.

“Independent secondary perils are less homogeneous and highly localised. Losses from perils like wildfire, flash floods, ice storms and cloudburst are, in the main, not modelled well and they can cause enormous damage as we saw lately in California,” Clinton said.

“Likewise, secondary effects of primary perils, such as the rainfall Houston took from Harvey and the tsunami that followed the Tohoku quake in 2011, also present modelling challenges. Primary peril ELs do not represent the only risk we run.”

Clinton said that, traditionally, underwriters would start with the expected loss on a risk and then supplement that guidance with their own knowledge and understanding of the risks involved—taking secondary perils into account. He said such nuance may have been missing from today’s underwriting processes which might partially explain why rates are still anaemic, but this must not happen going forward.

“There are enough smart people in this business that the clearing or consensus price in the market factors in the full risk; yet that price is still inadequate in many areas of the business at the moment.

“The investors in ILS vehicles are very sophisticated and hugely mathematically driven,” he said. “They are very keen to know exactly how we price our product and choose which clients to support. We spend a lot of time in webinars making them comfortable with our risk analysis and selection.”

Clinton said that, while he does not expect dramatic changes in rates in this renewal, he does expect some increases—and for rates to continue moving in a positive direction. He said this will partly be driven by the retro market which, he said, is undergoing significant change.

“Retro will move, and it will eventually drag everything else along with it. The Guy Carpenter property cat index sits at a weak 188 right now. We can do better than this for our shareholders—and we must.”