HIM fails to deliver what reinsurers hoped for

For several years, many market participants had believed that a big loss event would reverse the soft market. But cat losses costing $344 billion in global economic losses in 2017 (93 percent higher versus the 2000-2016 average) have delivered lower-than-expected rate increases in the January 2018 renewals, according to a recent Aon catastrophe report.

The impact from hurricanes Harvey, Irma and Maria (HIM) that wreaked havoc in the US and Caribbean in the third quarter of 2017 has been significant for many individual reinsurers.

Some have been particularly hurt

The losses incurred by RenaissanceRe, for example, represented 12 percent of the company’s shareholder equity, according to Fitch Ratings. For Lloyd’s of London, the hit represented 11 percent of shareholders’ equity. For Axis Capital as well as for XL Group the hit represented 10 percent of the companies’ shareholder equity.

“AXIS and XL Group were directly changed to a negative outlook as a result of the hurricanes,” Fitch Ratings director Graham Coutts explained during a Jan. 25 briefing in the City of London.

Bermuda-based re/insurer AXIS Capital Holdings has estimated the total net financial impact from third quarter 2017 catastrophe losses at $578 million.

XL Group estimated net losses of approximately $1.33 billion relating to HIM.

“Lloyd’s was put on a negative outlook before the hurricanes,” Coutts explained. But the result of the hurricane season has not improved the market’s situation. Lloyd's has estimated a total commitment of $4.8 billion for HIM.

Subsequently, Lloyd’s received approximately £3 billion of additional capital to restore capital resources to the level prior to the third quarter of 2017 loss events and to cover changes in capital requirements for 2018 underwriting.

Fitch reiterated its negative outlook for the London insurance market for 2018, reflecting the expectation that underwriting results are likely to stay pressured despite anticipated improvements in pricing conditions.

Underwriting results are expected to suffer from high expense ratios and lower contributions from reserve releases, the agency noted.

January rate improvements only moderate

Rate improvements on the back of HIM have been lower than expected, making it more difficult for re/insurers to recoup the losses incurred in 2017. The re/insurance sector has seen rates declining for several years in the property/casualty market.

While insured catastrophe losses in 2017 were at a similar level as in cat loss hit 2011 and 2005, the rate increases were significantly lower.

Although reinsurers sought to stem margin compression with more substantial rate rises at Jan. 1, 2018, many eventually ceded ground to clients as the date neared, particularly in non-loss affected areas, JLT Re said in a report.

JLT Re’s Risk-Adjusted Global Property- Catastrophe Reinsurance Rate-on-Line (ROL) Index rose by 4.8 percent at Jan. 1, 2018, with levels still below those seen in 2016.

After the big losses in 2005 and 2011 there was quite a significant spike in rates after those years, the increase in 2018 is not nearly so large, Coutts said.

The highest increases in the 2018 January renewals were recorded in the US, with rates renewing flat to up 5 percent for loss-free programmes and up 10 percent to 20 percent for loss-affected business, according to JLT Re.

Flat to moderately up renewals were typical for international property-catastrophe business, reflecting more benign loss activity in Europe and Asia. Even with these increases, the cost of property protection remains competitive with global property/catastrophe pricing approximately 30 percent below 2013 levels, the report noted.

Only single-digit rate increases are expected for 2018 following the large losses experienced in 2017, Coutts said.

“We do think that we are likely to see a flatter reinsurance cycle,” he said.

Alternative reinsurance capacity continues to grow

One of the reasons is that  capacity levels continued to be plentiful across most classes of business at Jan. 1, 2018. Whilst supply and demand dynamics initially tightened in business lines with heavy losses, pressures were offset by  post-HIM capital deployments through channels such as new collateralised vehicles, post-event funds, new catastrophe bond issuances and increased stamp capacity and pre-emptions, according to JLT Re.

Investors responded to opportunities in both the reinsurance and retrocession markets, resulting in the replenishment of a significant portion of lost capacity in time for renewals.

Alternative capital has seen capacity jump in recent years to above $80 billion in 2017 from less than $30 billion in 2011, according to Aon Securities data. Growth was driven mainly by collateralized reinsurance, but catastrophe bonds, sidecars and industry loss warranties also contributed to the increase.

“As these have been ramping up in size, we haven’t really seen these big cat years,” Coutts noted. “This year was a bit of a test for how the market might react,” he said.

Although the alternative reinsurance market incurred sizeable losses of around $10 billion in capital as a result of the 2017 catastrophes, they replenished that capital quite quickly in time for the January renewals, Coutts noted. The expectation is that the alternative reinsurance capacity will continue to grow, according to Fitch.

Operating profits in the sector will remain under pressure, Coutts said. With combined ratios near to 100 percent, profits will continue to be very sensitive to any significant cat losses. While rates have shown moderate improvements, this might not necessarily signal the start of a hardening market, according to Fitch.

M&A may be the solution

Instead, re/insurers might seek acquisitions to strengthen their position in the market and bolster results. “We do expect that there will be an uptick in M&A,” Coutts said. “Entities might be under a bit of additional strain following cat losses and they could turn to M&A as a way of better managing these challenges,” he explained.

Such M&A action is likely to involve Bermudian firms. Bermuda's major re/insurers will  report elevated combined ratios for 2017, averaging around 108 percent to 109 percent, according to Fitch.

The US tax changes are another reason why Bermuda is likely to be at the centre of a sector consolidation, Fitch Ratings director Graham Coutts suggested.

The 2017 cut in the US corporate tax rate to 21 percent from 35 percent and the new base erosion and anti-abuse tax (BEAT) will significantly reduce the long-standing tax advantage of Bermudian re/insurers over those in the US.

In a recent move, American International Group (AIG) will acquire Bermuda-based Validus Holdings for $5.56 billion.

The transaction enhances  AIG’s general insurance business, adding a reinsurance platform, an insurance-linked securities (ILS) asset manager, a presence at Lloyd’s and complementary capabilities in the US crop and excess and surplus (E&S) markets.

The recent deal of AIG and Validus is a good example, Coutts said. AIG gains a Bermuda and a London Market operation helping to diversify their platform, he noted.

“Expectation is that we are likely to see more of these types of deals throughout 2018,” Coutts said.