New money will chase harder rates but investors will exercise caution

As rates in many lines increase in the wake of several years of cat losses and COVID-19, many re/insurers are raising money in anticipation of cashing in on a hard market.

But the extent to which new capital will enter the market, the form in which it will enter and the extent to which it will flatten the curve, remain to be seen.

They were some of the points of debate at a panel discussion held on Intelligent Insurer’s Re/insurance Lounge, an online platform where interviews and panel discussions are held live on a weekly basis and content is available on demand at any time to members.

The session, called “The hard market and how some companies have raised money to leverage it”, featured two industry veterans AM Best’s chief rating officer and the managing partner of ILS Capital Management who discussed how they think investors will react to hardening rates and what that might mean for the cycle.

“The conditions are ripe for hard markets this year,” said Stefan Holzberger, chief rating officer at AM Best, noting that tailwinds promoting these conditions include low interest rates, a shrinking retro market, litigation finance and loss creep from prior catastrophes.

“These are very strong conditions, probably the strongest since the 2000s for a sustainable hard market,” Holzberger added.

John Warwick, managing director and partner at ILS Capital Management, noted that investor confidence is good, but capacity is being reduced two years ago, retro was being placed to around 140 percent of limits; this year, said Warwick, it will be 100 to 105 percent.

“With people reducing capacity, getting reinsurance programmes home on the retro side at the end of the year is going to be very tough. Consequently there’s going to be a huge uptick in pricing,” he said.

Re/insurers are looking aggressively at the rate increases they’re hoping to sustain on programmes, explained Holzberger, citing D&O as an area where, in some cases, there have been 75 percent rate increases.

“These forces were in play before the start of 2020,” said Holzberger. “But the uncertainty, the market dislocation, and the potential for financial market volatility have reinforced those trends and strengthened them,” he added.

There’s been an accumulation of weak performance across multiple classes, he said, noting that there isn’t just pockets of some rate hardening where it’s needed rate hardening is being seen practically across the board.

He explained: “With the low interest rate environment, the earnings need to flow through from the underwriting side. The market recognises that and it’s a strong catalyst for the rate increases we’re seeing.”

Warwick, who said that rate increases will be localised, territorial and by class, explained that people who haven’t had catastrophe losses will be very tough in saying they don’t want much of an increase at all.

He cited the example of a UK company which had recently doubled the amount of limit it wanted to buy, but its premium went up by 1,000 percent.

“If I were buying reinsurance, I’d have most of my narrative done already. By the end of the third quarter, I’d have all my losses and be straight out to market,” remarked Warwick.

“I don’t think you can hang around and hope that things will ease off.”

While there has been some capitulation in the last few years, where pricing has fallen off at the last minute, Warwick doesn’t expect that to happen this time.

Opportunities abound?
While the ultimate impact of the COVID-19 pandemic on the re/insurance market remains to be seen, some reinsurers appear better positioned than others.

Holzberger noted that for AM Best’s clients, which are active users of retro, the capacity isn’t there.

“Some reinsurers rated by AM Best have raised capital to take a bigger position in the market, because they feel unique opportunities abound for very strong technical pricing in that arena,” said Holzberger.

He added that, in addition to existing clients looking to raise capital to take advantage of some of these market dislocations, there is a pipeline of new ventures coming through the ratings process.

According to the AM Best executive, there are two camps in reinsurance sector. In the first, you’ll see some retrenching, with companies attempting to problem-solve and get their existing book of business in good order.

In the other camp are organisations that are underwriting at a reasonable return and seeing great opportunities in the market.

“They’re not having to spend valuable time fixing their existing book, they’re looking for new opportunities,” Holzberger added.

Looking into a crystal ball
In previous hard markets, capital has flooded in and things turned over time, but will the story be the same now?

“There are people looking to come in, but with the cost of reinsurance on any class going up and the amount of cover you’re allowed to buy going down, that will constrain the market generally,” Warwick explained.

He believes there will be companies who can’t service the amount of business they want to write, which will lead to the hard market continuing.

Holzberger acknowledged the market constraints.

“The days of spending half a year trying to set up a new Bermuda reinsurer or a US onshore re/insurance entity are not gone all together, but capital can now flow much more efficiently into funds, a sidecar vehicle or existing organisations,” he explained.

“With data and analytics having risen to a whole new level, these moments of really strong hard market conditions we generally expect to be short-lived.

“Once the information is out there, other organisations that have healthy business sheets will be going after same business.

“Ultimately that level of capacity will drive down the profitability inherent in those books of business,” he said.

Overall, despite the headwinds and difficulties in the industry, AM Best sees a very well capitalised market which is well-positioned from a capital and liquidity position to stand through the hard market.

Holzberger concluded: “Short of something very negative happening on the underwriting side, next year has the prospect of being a good year. Beyond that, I’m not so sure."

To watch the full video interview on which this write-up is based, click here and visit Intelligent Insurer’s Re/insurance Lounge.