Appropriate, sustainable pricing: What is it & how long will it last?

In the wake of recent catastrophe loss events, many major players in the global reinsurance market are pushing for rate increases at the renewals, seeking either to be paid back after bearing losses for their clients, or seeking pricing that they feel is more commensurate with the risks they underwrite.

Generally the market is expecting a pricing uplift, particularly in the market segments which have seen the greatest concentration of losses, so the retrocession market, as well as catastrophe reinsurance for Florida, Texas and the Gulf Coast, California, and the Caribbean.

But some are calling for broader rate rises, across the market and affecting lines of business outside of those actually impacted by the recent major catastrophe loss events.

Some of the largest reinsurers are pushing for rate increases across their books, a global, line-of-business agnostic price hike, which on the other hand many analysts and observers deem unlikely.

As why should rates rise where there haven’t been any losses and why would reinsurers even push for this? Unless they’ve been underpricing those risks over the last few years, of course.

It seems more reasonable to expect rate increases either where major losses occur and where the view of risk needs to change.

Mike McGavick, CEO of XL Group, stated in the companies third-quarter earnings release, “As we look at the global re/insurance markets today, with a view that we will see new levels of appropriate sustainable pricing, we believe we are well positioned by virtue of our diverse portfolio, global relevance and disciplined underwriting.”

Appropriate and sustainable.  Two words that could perhaps be swapped out for sensible and risk-commensurate.

Everybody wants to see this, having suffered their way through consecutive renewals where reinsurance pricing has declined significantly, eroding their returns on equity (RoE’s).

Prior to the impacts of hurricanes Harvey, Irma and Maria, and the more recent California wildfires, the best the reinsurance market could hope for was for something closer to stability at the key January 1st 2018 renewal season.

Now the market is hoping for a return to sustainable pricing, which would be welcomed, but the question is how long could it last?

Sustainable pricing for a traditional reinsurer means a level of risk and reward they can underwrite at over the longer-term, while paying losses when they happen and still feel compensated enough and able to deliver the level of return their shareholders want.

For an ILS fund manager or collateralized market, it is similar, except the ILS manager needs to make his target returns for his investors, rather than achieve an RoE. Additionally the ILS strategy can often have a considerably lower expense ratio than a traditional reinsurer.

Appropriate implies that this is pricing that it is correct to charge for the level of risk assumed. Sustainable implies that this pricing level will be revisited and reassessed on a regular basis, to ensure that underwriters can deliver on their promise to hold this risk over the longer-term.

In an ideal world, appropriate and sustainable reinsurance pricing would mean that we would never again see risks willfully underpriced, or terms and conditions stretched, just to get a client to sign on the dotted line.

But that’s unlikely to happen in a market where competition remains rife and capital abundant, even after losses.

We are in a situation where the appropriate and sustainable pricing of one underwriting strategy is no longer the same as the next.

This became abundantly clear with the growth of ILS and alternative capital, as more efficient and lower-cost ways to manage and deploy a pool of underwriting capacity came to the fore, leaving a gap between the traditional and alternative, as well as between strategies on either side.

Not every traditional reinsurance firm is operating to the same strategy and levels of efficiency, while not every ILS fund manager or collateralized reinsurance vehicle has the same cost-base, or accesses its risks in the same manner.

Efficiency can now be layered upon the underwriting of risk in many different ways.

With the ultimate goal being the creation of a portfolio of risk that meets your desired shape, mix and return targets, there are so many ways to slice and dice this market now that finding a level of pricing everyone could agree on being appropriate and sustainable seems impossible.

That’s actually the way it should be, of course.

One price does not fit all and why should it, which is especially true in a marketplace that uses leverage, has different levels of capital efficiency and where investment returns can augment the reach of its capacity.

So the traditional market itself is unlikely to ever agree on where appropriate and sustainable pricing levels sit, as they all have different levers to pull and return targets to meet.

So the ILS market is never going to have the same view on appropriate and sustainable pricing as traditional reinsurers, given the difference in their business models and return hurdles.

The appropriateness and sustainability of pricing can only be in the eyes of each underwriter, his executive team and of course his capital providers.

Given the constant evolution of the reinsurance business model, with ILS, the hedge fund reinsurance and total return strategies, underwriters targeting the sources of risk, players seeking to disintermediate the intermediaries, exchange trade risk directly on technology platforms, and other strategies that add layers of efficiency by accessing risk more directly, it is hard to imagine a market that isn’t characterised by competition on price and therefore pressure on returns.

So if pricing does revert to a level that some underwriters find appropriate and sustainable it may not be for very long, as there will always be someone who finds that they are happy with pricing at a level beneath that.

Ultimately this should be good for the end-users of risk transfer, the policyholders and protection buyers, as efficiency layers itself over insurance and reinsurance underwriting, ultimately making the transfer of risk cheaper and therefore more affordable for everyone.

But spare a thought for the executive teams, as the coming years are unlikely to be any easier than the last five or so have been (in our opinion). Prices may rise, but it’s difficult to see them being considered appropriate and sustainable by many or for very long.

Disruption is now such a broad theme in re/insurance, that even if pricing is found to be appropriate and sustainable the level it is found at will differ among players and is likely to be extremely short-lived.

Join us in New York in February 2018 for our next ILS conference