Lower pricing at the reinsurance renewals may be a new normal, particularly in catastrophe risks where the decline in pricing has been most evident, broker Aon Benfield discusses in its recent reinsurance renewal report.
One of the key discussions in the reinsurance market today is whether the current low-cost of risk capital is a “new normal” or whether the low-priced reinsurance environment has simply been created by factors such as low-levels of catastrophe risk, excess capital among traditional reinsurers and increasing amounts of alternative reinsurance capital in the form of insurance-linked securities (ILS) and collateralized reinsurance.
A case can be made that the new low pricing levels that the catastrophe reinsurance market is converging on could be a new normal, Aon Benfield said in its recently published Reinsurance Market Outlook report. Continued softening over recent renewal cycles has begun to slow, as the market converges on an opinion on where the floor for catastrophe reinsurance pricing may lie.
The report notes that there is of course a chance that the current record low reinsurance pricing is an “aberration” that could revert to pricing closer to longer-term averages should the market’s fortunes change. One factor that might lead towards this conclusion is that there is some continued uncertainty over the long-term sustainability of alternative reinsurance or ILS capital among both insurers and reinsurers.
However as the ILS market continues to develop and grow these concerns over the stickiness of the capital markets entrants are diminishing and becoming less prevalent. In fact, the majority of reinsurance market participants that Artemis interacts with are of the opinion that ILS capital is largely expected to be sticky and the pool of capital that has built up is deepening and becoming increasingly permanent as the market matures.
Aon Benfield makes a very important point in the report, saying; “There is no objectively correct price for catastrophe risk once premium covers expected losses and expenses.”
This is a really important point, which could be expanded to say, that as a result catastrophe risk pricing needs will differ between different companies, business models and especially between a traditional reinsurance company and an insurance-linked securities (ILS) player. I fact they will even differ depending on the risk model you use and your view of the risk itself.
So perhaps there is no single floor on catastrophe reinsurance risk pricing? We’ve written before that while capacity is one factor driving the reinsurance cycle there is a likelihood that the least conservative underwriters are responsible, to a degree, for also setting the price. But perhaps, in an increasingly ILS and alternative capital backed reinsurance market of the future, it will be the most efficient underwriters of risk who will set the most stable pricing floor.
If efficiency of the underwriter, in terms of a metric including expense levels and the cost-of-capital deployed, is going to be responsible for setting the price on reinsurance risks, it would suggest that we may indeed now be seeing a “new normal” in reinsurance pricing, at least in catastrophe risks where the influence of this more efficient capital has been most evident.
Aon Benfield notes; “Strong capital adequacy supported by the ability to generate new companies and catastrophe bonds quickly mute the impact of previously market disrupting events, and the asset class continues to gain favor with investors.”
If we’re in a “new normal” of catastrophe reinsurance pricing it suggests that the reinsurance cycle may never be the same again, as we’ve covered in detail before. However this may not apply to the broader reinsurance market yet, as non-catastrophe lines of reinsurance business, where risk premiums are lower, do not have the same scope for rate reduction as cat risks, Aon Benfield notes.
The historically low pricing on some catastrophe risks that we see today, which is especially prevalent in markets where ILS and new business models are becoming more dominant, certainly does seem like a “new normal” to us. It’s also clear that many ILS players are adamant that their lower cost-of-capital and efficiency will enable them to maintain lower pricing levels, that has now become part of the business model for this sector.
Of course even a “new normal” will at some point in the future no longer be considered new and will simply become the norm. The fact that we’re even talking about the current market environment as “new” suggests that ILS and alternative capital has a long way to go in its disruption of the reinsurance market.
While ILS as a practice is nearing 20 years old, we’re really still in the infancy of how this once niche part of the global reinsurance and risk transfer market will expand its influence. The current market could just be the start of a “new normal” and pricing may be the first element to normalise under the weight of capital. As ILS continues to develop its efficiency, technology and capital market risk transfer techniques, it may be able to pressure the traditional reinsurance market for many years to come.
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