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Uncertainty driving change

Source: Asia Insurance Review | Nov 2020

Tony Gallagher

Natural and human-made threats to economic growth, public health and productivity are increasing. Individuals, communities and businesses struggle with both the assessment of, and response to, the changing nature of risk. Global pandemics, climate change, sea-level rise, shifting population densities and extreme weather events are changing the nature of property risk. Technology, cyber events and the transition from an asset-based economy to an economy based on intangible assets contribute to evolving casualty risk. This changing nature of risk amplifies uncertainty, prompting adaptation in reinsurers’  approaches to managing risk, says Guy Carpenter’s Tony Gallagher.
 
 
Historically and understandably, uncertainty makes reinsurers nervous and increases volatility. Reinsurers are reacting to the changing nature of risk by exercising more caution as they seek to quantify the impact of shifts in previous assumptions. Uncertainty dampens reinsurers’ risk appetite and increases the cost of capital.
 
Impacts of uncertainty
Areas primarily affecting market uncertainty are loss activity (and development), operating expenses, underwriting profitability, investment returns and the availability of capital. All these factors drive the cost of reinsurance, so understanding and skilfully managing them are key to successful navigation of market dynamics that are constantly evolving. 
 
Loss activity. Loss costs are a major influencer of underwriting profitability. Actual significant insured losses as well as the perceived threat of losses have increased over the past few years. Setting aside pandemic loss, the loss drivers in third-quarter 2020 were:
  • Severe convective storms (thunderstorms with tornadoes, floods and hail) caused insured losses of over $7.5bn, including Kyushu floods in Japan with $2.1bn of loss 
  • Losses from US wildfires are estimated at $6.5bn
  • Hurricane Laura has caused insured losses of $5.4bn
  • The average third-quarter loss from 2011 onwards is approximately $21.1bn
 
Global insured pandemic loss is still highly uncertain. Estimates vary between $20bn and over $100bn. The impact of COVID-19 and catastrophe losses on underwriting results in 2020 remains unclear.
 
Significant insured losses – 2011-3Q2020
 
Operating expenses. Uncertainty in the loss ratio encourages (re)insurers to reduce operational costs, prompting an eye toward solutions such as leveraging technology to achieve greater efficiencies. For example, in its half-year 2020 results, Lloyd’s reported a slight improvement in its expense ratio, to 37.7%, from 38.1% in 2019. 
 
Underwriting profitability. Balance-sheet pressures from catastrophe losses since 2017 and COVID-19 uncertainty are pushing insurers and reinsurers toward more selective underwriting. 
 
According to data from Marsh, primary rates are rising globally. Within Asia, financial lines and property have led the increases, with general liability rates increasing more slowly. 
 
Global reinsurance pricing is also increasing, partly due to catastrophe losses and factors such as social inflation, leading to greater uncertainty in past performance adequately accounting for future risk exposure. This trend is expected to continue through the 2020 renewal cycle.
 
For reinsurers in Guy Carpenter’s Global Reinsurance Composite, the last four years have shown higher combined ratios – in line with loss impacts. Reserve releases, which helped results in 2008-2016, may no longer be available. 
 
Guy Carpenter Global Property Catastrophe Rate-On-Line Index: 1990 to July 2020
 
Investment returns. The prolonged low-interest-rate environment is pressuring investment income, triggering downgrades of some reinsurers’ credit ratings and financial strength ratings. A September report by Moody’s Investors Service indicated a negative outlook on global reinsurance, citing “low interest rates, shrinking reserve releases and uncertainty around ultimate pandemic losses”. Moody’s believes these factors will outweigh pricing increases.
 
Capital availability. Responsive capital fuels market dynamics. In 2020, capital constraints in the retrocessional market, a narrow but important resource for reinsurers, fuelled rate increases of 20% to 30%, which impacts selected reinsurers’ ability to provide capacity.
 
Reducing uncertainty
Uncertainty for the thoughtful insurer and broker partner can be a synonym for opportunity. The reinsurance broker is both the gateway to accessing these opportunities and the insurer’s source of market intelligence and specific expertise. It is the insurer, however, that has the key to realising these opportunities. Reinsurers will reward with support insurers that know their portfolio, understand the changing nature of risk, and have well-thought-out strategies and work with their reinsurers in a collaborative, disciplined and professional fashion. 
 
Insurers may consider the following steps in planning a reinsurance marketing strategy: 
  • Building trust. Insurers can build trust with reinsurers and reduce uncertainty by prioritising transparency in data quality and other material performance factors. 
  • Market dynamics. Reinsurance markets approach risk differently. Understanding factors influencing reinsurers’ view of risk enables a clearer evaluation of how to build the most effective partnerships. 
  • Innovative structures. Traditional reinsurance treaties and facultative coverage are not insurers’ only options. Innovative structures have emerged, including sidecars, collateralised reinsurance, parametric solutions, aggregate coverage and loss portfolio transfers (LPT). Insurers should consider their needs and explore alternatives. For example, is earnings protection a higher priority than capital protection? Does exiting an underperforming line through an LPT offer more advantages than non-renewal and runoff? The variety of innovative and customisable structures is positive news for insurers.
  • Other forms of capital. Despite the uncertain environment, in 2020 the insurance industry has raised $35 billion in new capital to date, which has flowed into different sectors, from P&C to life/health. The catastrophe bond market remains robust, offering good liquidity and performance in line with investor expectations. Although limited capacity exists in insurance-linked securities (ILS) for pandemic risk, many other risks can be funded through ILS. This area appears to offer great resilience in uncertain times.
 
The opportunities for the (re)insurance sector are vast and complex and will require thinking about risks beyond what is currently known and measurable. Navigating uncertainty and the changing nature of risk is challenging but possible, with the appropriate innovative strategies and solutions. Guy Carpenter is committed to staying on the forefront of the evolution. A 
 
Mr Tony Gallagher is CEO Asia Pacific region for Guy Carpenter.
 
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