Reinsurers’ margins are not aligned with rates in the primary market
The property catastrophe reinsurance market, which has suffered from significant losses over the last five years, is at a tipping point.
The expectation is over the next eight months reinsurers will make a concerted effort to shift the basis on which they price most perils in most territories. The main focus, however, will be perils such as wildfires and floods, which at the moment the market classes as secondary perils.
With most property catastrophe renewals happening between January 1 and July, 1 the nature of the discussions reinsurers are having with cedants during the last quarter of this year will be crucial, experts say.
Over the past two years or so reinsurers have sought to increase their understanding of the changing nature of the risk represented by natural catastrophe events, according to Patrick Hartigan, global head of reinsurance and chair of the Asia-Pacific management committee at specialty London market carrier Beazley.
A critical mass of reinsurers – from some of the biggest players in the market to individual Lloyd’s syndicates – are now ready to act on those findings, Hartigan says. The market will assess and rate these perils based on real-time (rather than historical) data: a radical approach to underwriting that is “forward- rather than backward-looking”, he says.
For this renewal, the market is taking on board the issues of climate change and climate variability. “It understands climate change is here to stay and climate variability needs to be factored into the rating,” Hartigan says. This is in part because the cost of property catastrophe reinsurance capacity is increasing for companies, as investors are now no longer willing to deploy capital in an area that has been loss-
making for the past five years. Therefore, for the reinsurance market to maintain present levels of capacity, it will require a rate that is in line with the risk.
This is an important market shift for Beazley’s reinsurance division, which accounted for close to 5.5% of the $3.5bn in gross premium written by the group in 2020, indicating ample room for expansion.
The division is almost entirely focused on property catastrophe risks, which comprise 90% of the business written. Given the challenges in the class in recent years, the strategy has been to limit Beazley’s presence and exposure in the property catastrophe market through a process of rigorous client selection. “We aim to manage the cycle. We have never been under pressure to push growth beyond what is profitable and, therefore, we can afford to be more selective,” Hartigan says.
In addition, certain market trends have further limited the scope of the reinsurance division, which writes property catastrophe risk on a worldwide basis. For example, the extensive remediation in the primary markets is one of the reasons why Beazley as a group has refocused its capacity on primary business.
“What we have seen over the past few years is the margins in reinsurance do not reflect what is happening with rates in the primary market and that is why our overall reinsurance business has not grown as much as our primary business,” Hartigan says. Beazley also writes reinsurance within its other divisions, particularly in specialty lines and personal accident. The combined reinsurance premium accounts for around 10% of group premium.
With property catastrophe reinsurers seeing severe losses hit their portfolios over the past four years, rates are expected to continue to rise. “We have had losses in Japan, Europe and the US, so the overall market requires an increase in rates,” Hartigan says.
The expectation is for a baseline reinsurance rate increase of close to 10% but Hartigan believes the average increase will veer more towards 15% to 20%, with some cedants, particularly those in Germany (where companies have suffered specific losses and have in many cases exhausted their programmes), being subjected to a 50%-plus increase. “We see this as an opportunity to increase support for our global clients while delivering a profitable outcome for our investors,” Hartigan adds.
Beazley’s reinsurance division, which has been writing property catastrophe reinsurance for 35 years, will be well positioned in the new market environment, Hartigan says. “We are never going to be the largest capacity provider in the market but we feel we are able to identify clients, particularly in the mature insurance economies, that have the capability through superior claims management, underwriting or actuarial expertise to outperform the market in the long term when it comes to particular territory or a peril.”
There are other, more subjective elements to the way Beazley’s reinsurance division underwrites, according to Hartigan, “but strong client selection, with geographical diversification superimposed on it, is the bedrock of our philosophy”. He describes the property catastrophe portfolio, of which the largest part is the US, as geographically well spread, while the portfolio is further diversified in terms of natural perils versus non-natural perils such as fire.
At present, 80% of Beazley’s biggest property catastrophe clients have reinsured with the group for 20 years or more. “We believe in managing the volatility over the long term but we’re willing to take it on. That is why we are, almost exclusively, an excess-of-loss player and very much focused on attachment levels. We don’t want to be paying small market losses, which have been an issue for our sector over the past couple of years,” he says.
This is because the lower the attachment point, the more perils the company is exposed to. “What we are trying to do is to get beyond that to provide core reinsurance capacity for clients. We are not opportunistic. It is about protecting clients’ capital, rather than their earnings,” Hartigan says.
But it has been tough going, even for Beazley, in a property catastrophe market that has not been profitable for the past five years. “It has been profitable for the past 10 years, but not for the past five,” Hartigan says.
Beazley remains committed to and continues to invest in the market, “and as long as we can do that then the management and our investors will be confident we can make a long-term profit”, Hartigan says.
Indeed, the reinsurance division improved its combined ratio from 154% in 2019 to 105% in 2020 and that improvement has continued into 2021. For example, the division’s attritional accounts are performing better as a result of rate increases across the entire portfolio this year. The division has also been less affected by prior-year losses in the US. “Losses from Hurricane Irma are levelling off, as it should do because we are four years beyond the event. But we are very much aware of the potential increase in prior- year losses. It is one of the idiosyncratic features of the Florida market,” he says.
For the past few years Beazley has been trying to move to a strict per-peril and per-territory rating methodology, according to Hartigan, but until recently the market has been very resistant to the transparency associated with this approach to property catastrophe underwriting. “There have been significant losses for perils, including some of the recent floods in Europe, the hailstorms and the Texas winter freeze. This is a big part of the reason why we have kept our premium volume fairly level in recent years,” he says.
Loss creep, he continues, remains a problem for the market, particularly when you have what is regarded as a short-tail class and you have losses developing three, four, five or even six years down the line “and, sometimes, the increases are quite significant. And I refer here to the New Zealand earthquake losses”, he adds.
Loss creep has particularly had an impact on the insurance-linked securities market. “Investors in that market don’t want to have their capital tied up. If the capital is trapped because of losses, that’s one thing. But if it is tied up for longer than 36 months, that capital is not producing a return for them, so the pressure on the market to manage loss creep is quite significant,” Hartigan says.
Elsewhere, Typhoon Jebi was more about average claims being much higher than initially anticipated as a result of what reinsurers perceived to be a low inflationary environment in Japan. “It was a low inflation environment, but not for the average claim. Inflation is a major issue and something we’re very aware of. We are now very focused on getting the right rate increases and making sure that insured values reflect those inflationary pressures,” Hartigan says.
Indeed, these days the focus is very much on insured values. Many companies, particularly in the US, Hartigan says, will include an inflation guard by adding a percentage on to their insured values. That percentage will typically be a little bit higher than retail or consumer price inflation and will be updated every one to three years. “But it very much depends on who you are dealing with. Most companies have an indexation factor, but it is a question we always ask because that’s what we have to do. If the companies are not inflation indexing, it means we have to do that indexing ourselves,” he adds.
This article has been first published in Insuranceday.
“What we have seen over the past few years is the margins in reinsurance do not reflect what is happening with rates in the primary market and that is why our overall reinsurance business has not grown as much as our primary business”