Pandemic risk could transfigure alt cap market, says Fitch’s Schneider

“It’s a very difficult risk to insure and some would say it’s uninsurable, but pandemic risk is definitely something that’s going to have be tackled by the industry, given some of the reputational damages the industry has suffered as a result of business interruption issues,” says Brian Schneider, senior director at  Fitch Ratings.

He believes there’s a lot of potential for the industry to do better, whether it’s on transferring risks to the alternative capital market or figuring out ways to price risk on their own balance sheets.

Speaking with the Re/insurance Lounge, Intelligent Insurer’s digital hub for interviews, debates and panel discussions, Schneider explained that transferring pandemic risk to the alternative capital market could have a big impact on the market itself.

Earlier this year Aon reported that global reinsurer capital reached $650 billion at the end of 2020, consisting of $533 billion in traditional capital and $92 billion in alternative capital.

Alternative capital now makes up around 15 percent of global capital, but 10 years ago it made up 6 percent of the market, says Schneider.

“Since 2015, it hasn’t moved much,” he added. “It would take some sort of an important breakthrough within that market to reach a new type of level of commitment from investors.”

According to Schneider, the transfer of cyber risk or pandemic risk to the capital market could be that important breakthrough.

Opportunities and market transitions

Cyber risk is an issue that Fitch is following closely. “Cyber reinsurance represents one of the biggest opportunities for coverage, but at the same it’s also one of the biggest threats for lawsuits,” he said.

He believes that, overall, the industry has been prudent and measured in not taking on cyber risk, with 40 percent or so of primary cyber risk reinsured.

“Could the industry have been more a bit more innovative and tried to take a larger portion of this risk? Potentially, but given that historical data is not very useful, we think cyber will remain more of a niche type of product right now—albeit an important and growing product,” he summarised.

Environmental, social and corporate governance (ESG) factors are another issue the rating agency is keeping its eye on, partly through including scores for ESG across its rated universe.

For re/insurance, says Schneider, climate change has been a big issue.

“We see it being increasingly a more important topic for the industry, from both the investment side and the underwriting side,” he said. “The industry will certainly have to increase its disclosures around ESG factors, providing more transparency to investors, and also look to revamp its underwriting and investment policies to satisfy investors.”

The big push for more sustainable finance is not going to decline any time soon, he said, noting that the industry is seeing reductions, as well as withdrawals, on reinsurance coverage related to coal and fossil fuels.

“With reinsurers as experts of risk management, we expect them to be able to play a leading role in this market transition,” added Schneider.

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Stable to improving

Fitch has revised its fundamental outlook on the reinsurance sector to improving from stable.

“While pricing at the various 2021 renewals was lower than reinsurers expected, as rate momentum slowed, reinsurers have continued to secure premium rate increases since mid-2019. It’s the best market overall since 2005,” said Schneider.

Pricing remains inadequate in the face of many issues including heightened catastrophe losses, low insurance rates, climate change risks, uncertainty on the strength of economic recovery, and concerns regarding the impact of claims and social inflation, he added.

Fitch expects rate increases to continue at the January 2022 renewals, although they will be somewhat reduced (high single digits, potentially low double-digit levels). “Rate adequacy is not being approached just yet, so we will still see some push there,” said Schneider.

“If you look at where the industry came from through the first half of this year, premiums written grew by 18.5 percent. We’re seeing those prices come through within the financials of companies. Demand for reinsurance remains strong.

“Given those rate increases and the fact that we’ve also seen a shift to more quota share business, which is benefiting from the rate increases we’re seeing on the primary insurance side, there’s also growth in casualty and specialty insurance writing. This is driving a positive market around rates.”

As a result of this, Fitch is seeing combined ratio improvement for companies, by approximately two to three points. The rating agency expects improvement of one to two points in 2022.

“These rate improvements are going down to the bottom line. They are decelerating, but they are remaining ahead of the loss cost increases. As a result, we also expect net income return on equity in 2020/21 to be nearer 10 percent, which is the first time we’ve seen this since 2019 when we were close to that level,” said Schneider.

However, the big assumption with all of these improvements is that catastrophes are ‘normal’ for the rest of the year.

Turning to new capital flowing into the industry, Schneider noted that new companies may have dampened pricing. However, it wasn’t a big wave of capital ($5 billion), he added.

This lagged behind the $10 billion plus of capital from existing reinsurance companies, which was required to “fill some of the holes because of the pandemic losses but also to take advantage of new market opportunities”, he said.

“We see this new capital being primarily run by experienced industry executives and private equity investors who have expectations for return. They look to be focused on providing very disciplined long-term capacity, so there are not too many concerns there.

“It’s good to see new blood and new capital come into the market,” he concluded.

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