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Jun 2019

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Reinsurance renewals: Pricing remains stable, reflecting a maturing market

Source: Asia Insurance Review | Feb 2019

How did the reinsurance industry fare at the January renewals and what is the outlook for 2019? 
By Chia Wan Fen
 
 
Last year was the fourth most costly in terms of CAT losses in real terms after the record insured CAT losses of $150bn in 2017, according to JLT Re. While both years constitute the most costly two-year period ever for insured catastrophe losses, they are unlikely to come close to challenging the combined, inflation-adjusted, reinsured losses sustained in 2004 and 2005, it said.
 
Despite this setting, continued resilience in reinsurer capital and abundant capacity meant that there was no major shake up to pricing generally at the 1/1 renewals, although there were rate increases specific to classes with poorer performance. This can be as a sign that the reinsurance market has matured and even major losses may see only a measured reaction through rates. We take a look at the renewals reports of four major brokers. 
 
Value proposition to buyers remains high: Aon
It’s still reinsurance buyers’ market, as they continue to secure protection at accretive cost of capital terms despite a reduction in global reinsurer capital in the first nine months of 2018, according to Aon’s annual Reinsurance Market Outlook.
 
Global reinsurance capital overall fell 2% since end 2017 from $605bn to $595bn as at 30 September 2018. While traditional capital dropped 4% in part driven by rising interest rates and a stronger US dollar, total alternative capital rose 11% to $99bn - an increase of $10bn since the prior year end.
 
Insured CAT losses over the past two years aggregate to approximately $230bn. While 2017 created a new peak at approximately $147bn, 2018 losses alone are currently estimated at $85bn, 47% higher than the 2000-2017 average of $56bn. While these losses are widespread, they were still a substantial burden for the (re)insurance industry to absorb.
 
Despite the fall, however, reinsurance capital remained resilient in the face of the losses and excess reinsurance capacity continues to exist, despite an increase in demand for reinsurance solutions on a global basis.
 
Traditional reinsurers continue to display strong risk-adjusted capitalisation, utilising the capital markets to manage their gross exposures, carry significant budgets for net natural catastrophe losses and rely on investment returns to underpin their earnings. As a result, they have generally been able to trade through recent events without capital impairment.
 
The impact has been more significant in the alternative capital sector, said Aon. “Many investors in the final quarter of 2017 have experienced some combination of lower than expected pricing, ‘creep’ on 2017 events and further losses in 2018. Significant amounts of collateral have become trapped and the ongoing commitment of newer participants is being tested. This is affecting areas most dependent on this form of capacity, notably the retrocession market.”
 
Despite large reductions in some individual placements, there was a slight uptick in reinsurance demand for January renewals. There were slight increases in traditional products and lines driven by regulatory requirements, continued attractive market dynamics for buying, and recent losses in non-peak territories that have advocated for more robust coverage for these perils. However even then, capital supply outstrips demand.
 
Aon’s report also noted that with higher data quality across all markets, there has been continued refinement in pricing and rate change driven by individual client, line and territory experience. 
 
Looking ahead
As the market continuously looks for new ways to deploy capital, further analysis continues on a number of evolving risks including familiar ones to the market (flood, cyber and government de-risking) as well emerging risks (sharing economy, food-borne illness, and longevity and pension shortfalls). The latter have seen growth in buying and increased analytics investment, which Aon expects will translate to increases in risk transfer.
 
Aon expects the April renewals to see similar market dynamics to 1 January given the composition of the renewing business.
 
Limited fluctuations in reinsurance rates from CAT losses: Guy Carpenter
The overall impact of catastrophe losses on property rates was muted at the 1/1 reinsurance renewals, but the fourth highest annual CAT loss year on record did create questions over pricing adequacy, underwriting strategy and the amount of capital available, said Guy Carpenter’s annual renewal report.
 
The company said potential sector pressure from global CAT losses in 2H2018 and continued development of 2017 claims was at least partially offset by plentiful capacity, which led to its Global Rate on Line (RoL) Index, a measure of change in CAT premium dollars paid y-o-y, increasing by just 1.1% despite back-to-back years of major loss accumulation.
 
Contributions to the index from the two largest sectors, the US and Europe/Middle East/Africa (EMEA), increased by 2.6% and decreased by 2.5%, respectively, but there was a wide degree of variation within these results depending on account specifics. Brexit uncertainty meant some in Europe were less keen to use Lloyd’s, but this had little effect on renewal outcomes as additional capital was available.
 
Japan also saw significant CAT activity - but until the 1 April renewals, where most Japanese programmes tend to be renewed, the impact will not be evident yet.
While upward movement in property pricing was limited to localised activity, the effects on profitability from losses in this sector put pressure on other lines to achieve or maintain self-sustaining levels. As a result, in addition to increases on loss-impacted business, increases on some non-loss-impacted casualty and specialty business were achieved.
 
“While the impact on 1 January renewals overall was muted, this was a more challenging environment for some segments than it was a year ago. The industry is dealing with questions of pricing adequacy and where and to what degree adjustments might be needed. Finding equilibrium was not always easy and questions remain coming out of this renewal,” said Guy Carpenter vice chairman David Priebe.
 
Looking ahead
Conditions for the renewals later this year are uncertain, as capital providers integrate recent experience into their market approach. Diminishing profitability as well as uncertainty over the amount of available convergence capital impacted retrocessional renewals at 1 January, but it is unclear what this might mean for broader market dynamics going forward.
 
As the events of 2018 unfolded and 2017 losses continued to develop, increasing amounts of collateralised capital were lost or restricted by trust agreements. If this trend continues, or capital providers in general are more conservative in their commitments, deployable capacity may become more broadly constrained. However, there are also signs capital may increase, with several initiatives reportedly in progress to bring in new funds.
 
Emerging risks are creating new challenges, noted Guy Carpenter. The effects of climate change are not fully known but may shape the industry’s future assessment of exposure to loss, while cyber is a risk that could rival or exceed the exposure from any event currently considered. 
 
Market participants may need to adapt their approach to a shifting landscape, but capacity is likely to remain plentiful for risks that can be adequately measured and priced.
 
Reinsurance market enters ‘uncharted territory’ at 1/1: JLT Re
Reinsurance renewals at 1/1 defied early expectations of post-loss firming for the second year running, as reinsurers’ desire and ability to underwrite risks remained healthy overall, said JLT Re, another broker that also saw muted impact on rates.
 
Market conditions nevertheless deteriorated in some areas as dampened reinsurer appetite, as well as increasing demand, was observed for business classes that suffered sizeable losses or where performance has deteriorated in recent years. 
 
Loss experiences for P&C were acute after the CAT of 2018 – including hurricanes Florence and Michael, typhoons Jebi, Mangkhut and Trami, flooding in Western Japan and the Californian wildfires – cost (re)insurers over $80bn. In addition, a number of large risk losses in several property and specialty classes occurred throughout the year, although abundant capacity generally offset upwards pricing pressures here.
 
Renewal outcomes for global market property
Capacity constraints in the retrocession market dominated the 1/1 renewals. The quantum and timing of 2018 CAT losses was such that a sizeable portion of retrocession capital, the bulk of which is provided by third-party investors, was trapped for a second consecutive year. 
 
In addition, investor appetite softened in the fourth quarter, especially when compared to the same period in 2017. Appetite had been moderating throughout 2018 due to lower-than-expected returns and loss deterioration from 2017 events. Many ILS funds therefore confronted a more challenging environment this renewal, as claims mounted from hurricane Michael and the California wildfires (both $10bn+ events) as well as typhoon Jebi, the strongest typhoon to hit Japan in 25 years. A series of redemptions and a difficult round of fundraising followed, with lost or trapped capital not being replenished to the same degree as last year, according to JLT Re’s analysis.
 
 This contributed to an increase in retrocession rates by double digits on loss-affected layers at 1 January 2019, although the overall pricing picture was more nuanced than in 2018 as distinctions between occurrence and aggregate covers and traditional and ILS markets became more pronounced. 
 
“After another year of significant losses and locked capital in the retrocession market, rates for loss-affected catastrophe layers were generally up by between 10% and 20% on a risk-adjusted basis, with aggregate covers falling towards the upper end of this range. Many clean occurrence retrocession programmes were renewed flat to up 10%. Global and Lloyd’s direct and facultative (D&F) catastrophe covers were less affected by 2018 losses and, after strong increases at last year’s 1 January renewal, rate changes in 2019 were typically down 2.5% to down 7.5% on a risk-adjusted basis,” said JLT Re deputy CEO of UK and Europe Bradley Maltese.
 
Reinsurance property-catastrophe
Spillover into the primary property-catastrophe reinsurance market was limited, possibly reflecting the relatively modest amount of loss-affected business up for 1/1 renewals. JLT Re’s Risk-Adjusted Global Property-Catastrophe Reinsurance Rate-on-Line (ROL) Index fell by 1.2% at 1 January 2019, after increasing by 4.8% at 1 January 2018. This year’s modest decline leaves the index below levels recorded in 2016. Indeed, the cost of property protection remains competitive with global property-catastrophe pricing approximately 30% below 2013 levels.
 
JLT Re in north America CEO Ed Hochberg said, “Despite another active catastrophe year in the United States, property-catastrophe rate changes were modest at 1 January 2019. Loss-free layers saw relatively muted movements, typically falling within a range of flat to down 5%. Strongly performing accounts renewed towards the lower end of this range as cedants argued (often successfully) that another clean year merited risk-adjusted decreases in 2019. Loss-impacted layers generally saw price rises, but outcomes varied depending on losses, geographies, exposures and relationships.”
 
Sizeable losses also occurred outside the US in 2018, not least in Japan, but rate movements in Asia Pacific at 1 January 2019 generally saw single-digit reductions due to relatively benign loss activity in the territories that renewed on this date. Pricing pressures were negligible even in the few Asian markets that did sustain losses in 2018 (e.g. China with typhoon Mangkhut and Indonesia with the Lombok earthquake). 
 
Casualty
The 1/1 renewals saw the emergence of a more challenging environment in the casualty reinsurance market. JLT Re CEO UK and Europe Keith Harrison said, “A combination of increased severity, social inflation and instances of adverse reserve development has seen reinsurance margins squeezed in a number of casualty lines. This led to more cautious risk appetites, downward pressure on ceding commissions and some upward pressure on reinsurance rates. Specifically, commercial auto, professionally liability, medical malpractice, per person workers’ compensation and umbrella/excess casualty all experienced more challenging renewals than in recent years.”
 
Mounting pressures were also evident for global casualty as loss-free programmes renewed close to expiring levels whilst moderate increases were observed for loss-affected accounts. Similarly to 2018, these outcomes were often accompanied by lower ceding commissions, particularly for loss-affected programmes. 
 
Specialty
The specialty market typically saw strong levels of capacity offset any upward pricing pressures that came from successive years of rate decreases and rising loss trends. Most programmes were broadly flat or slightly reduced in cash terms, which generally led to risk-adjusted outcomes ranging from flat to down double-digits. Results continue to be strong, despite the attrition fuelled by certain large risk losses affecting the market in 2H2018. 
 
Uncharted territory
JLT Re global head of analytics David Flandro said, “Sustained capital inflows have offset mounting pricing pressures to bring relative stability to the reinsurance market over the last several years. Record levels of dedicated sector capital at year-end 2018 once again helped ensure continued, plentiful capacity across most lines at 1 January 2019. 
 
“A small portion of excess sector capital was nevertheless absorbed in 2018 by sizeable insured catastrophe losses in the second half of year, a reduction in third-party deployable capital, higher demand for reinsurance and a renewed focus on underwriting discipline, as shown, for example, by reduced stamp capacity and higher capital requirements at Lloyd’s.”
 
Early analysis by JLT Re found that alternative capital growth in 2018 abated for the first time since the global financial crisis. This is consistent with the tightening observed in the retrocession market as some investors pulled back allocations due to what were perceived as disappointing returns throughout the year, continued loss creep from hurricane Irma and another series of costly catastrophe losses in 2018. 
 
That said, it is important to stress that strong competition at 1/1 ensured that placements, whilst late, were completed in good order for the most part and capacity was only pared back in areas where major losses occurred or where return hurdles were not met. This is a market which has clearly matured since the days when large catastrophes created massive price volatility. The reinsurance sector today remains exceptionally well capitalised, even at a time of macroeconomic change and unprecedented catastrophe loss activity. 
 
Looking ahead
“Loss experiences and the macroeconomic environment will play an important role in shaping the reinsurance market in 2019. Another large-loss year could test the limits of carriers’ capital resilience, as well as investors’ appetite for reinsurance at a time of capital market volatility. Carriers’ balance sheets could also come under additional strain as the economic cycle shows signs of shifting for the first time since the immediate aftermath of the financial crisis. Reserving trends and asset leverage remain key sector drivers. After a prolonged period of low yields and disinflation, the spectre of sudden movements in interest rates and asset prices bring important supply implications,” said Mr Flandro.
 
Contrasting realities: Willis Re
Despite a relatively benign 1H2018, the second half of the year saw losses exceed the 10-year average, with insured CAT losses for the full year 2018 over $70bn. The spillover effects of the 2017 CAT losses, particularly hurricanes Irma and Maria, and an increase in large losses from non-CAT risks has further impacted results, exposing the continued marginal returns in a number of lines and reinsurers’ struggle to achieve sustainable profits, said Willis Re global CEO James Kent.
 
For Willis Re, the 1/1 renewals reflected a pricing gap between accounts with peak peril exposures or poor loss records and those with good loss records and/or non-peak exposures.
 
The quality of client counterparties was an important factor for reinsurers when it comes to risk selection, said Willis Re’s 1st View renewals report. It noted that two different trends were evident in property catastrophe renewals, where cedants with good loss records and a disciplined, early renewal process achieved risk-adjusted rate reductions, while loss impacted accounts and clients viewed as of lesser quality are seeing upward pricing across a number of lines.
 
The insurance-linked securities (ILS) market is facing a more comprehensive test as higher returns post-2017 losses did not materialise as anticipated. Furthermore, additional capital has been trapped from the 2017 loss creep. While most of the 2018 losses have emanated from well-known perils such as US hurricane, Japan wind, flood and earthquake, the secondary peril of wildfire has again generated substantial losses. 
 
Some ILS products, most noticeably aggregate catastrophe and retro covers, have performed poorly for investors, thereby resulting in less available capital. However, this is balanced by other ILS products that have continued to deliver acceptable returns. Those funds with long-standing and successful track records, consistent and well-regarded management teams, and flexible trust language or fronting agreements are the ones best equipped for success.
 
Adjustments to business models initiated over the year have taken on an increased urgency, including some pulling out of unprofitable lines completely or seeking more aggressive rates improvements on underperforming lines. There have also been changes within the Lloyd’s market targeting the bottom performers. As a result, some lines are seeing significantly larger rate increases than treaty reinsurance business. 
 
Reinsurers have benefited from increases in premium ceded by large carriers, notably through large new pro rata cessions where terms have slightly tilted in reinsurers’ favour. At the same time, major reinsurers’ strength and client-centric flexibility remain key to large cedants’ goal of dampening earnings volatility. 
 
Mr Kent said, “In the immediate aftermath of the 2017 catastrophe losses, many observers felt the measured reaction of the reinsurance market was a clear sign of a changing structure and maturity. Others more cautiously suggested time was needed to properly assess the impact of 2017 events. 
 
“In the wake of the high loss activity during the second half of 2018, early renewal negotiations have proved prudent, while pricing in the primary market has given reinsurers some cause for optimism in light of the increased pro rata cessions from clients.” 
 
As 2019 pricing unfolds, the mid-year renewals may help to answer the longstanding question over how much impact the retro market has on first-tier reinsurance property catastrophe pricing levels.
 
Asia Pacific
Offering a regional perspective, Willis Re Asia-Pacific managing director Mark Morley said that overall demand was stable with buyers maintaining reinsurance purchase levels to help stabilise their earnings. 
 
“Reinsurance pricing was down on a risk-adjusted basis despite the poor 2H2018 which was not in line with many reinsurers’ expectations, though those writing proportional treaties where primary rates have started to show some signs of increases are encouraged by this trend,” he said. “For ILS investors the Nat CAT pricing environment did not meet their expectations following the poor 2017 results.”
 
This situation was a result of continued overcapacity despite the recent losses – still relatively modest on a single-event basis--and traditional reinsurers willingness to support their preferred clients by adopting client centric underwriting strategies. 
 
“In a few areas where trapped ILS collateral led to some capacity shortages such as aggregate retro, some traditional reinsurers were prepared to support at the offered higher prices and at the same time a number of buyers reduced their retro-buying alleviating any potential capacity issues,” said Mr Morley. A 
 
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