Chronic underpricing of risk leads to natural inflection point: McGavick, XL

The reinsurance industry has been guilty of chronically underpricing catastrophe exposed products, which means it is natural that following major losses such as the hurricanes and earthquakes seen in Q3 2017 the market reaches an inflection point as it looks to reprice, according to Mike McGavick, CEO of XL Group Ltd.

Speaking yesterday in Bermuda at the 2017 Bermuda Reinsurance Conference held by S&P Global Ratings and PwC Bermuda, McGavick discussed the need for the reinsurance market to find a pricing level where participants can agree that they are being paid correctly for the risk they assume.

“Underwriters are awake to the fact that they were selling their products for less than their cost,” McGavick explained. “And once they’re awake, they don’t go back.”

He said that the question now is how broadly price rises are to be found across the industry, adding that he feels reinsurers catastrophe linked products have been “chronically underpriced” which makes a pricing inflection point a natural occurrence after the impacts of hurricanes Harvey, Irma and Maria.

“The question is really, ‘How far will it spread?'” McGavick continued, and said that the losses are not just a test for alternative capital and ILS, as many have said, but are also “a big test for the traditional reinsurance market.”

Also speaking at the event, Marc Grandisson, President and COO at Arch Capital Group Ltd., said that many reinsurance buyers have already resigned themselves to the fact that there will be price increases at the January renewals.

“When you talk behind closed doors with the most senior brokers, they understand that things need to change,” Grandisson said “There’s a recognition from the community of buyers that there needs to be some correction.”

Additionally, terms and conditions are expected to tighten at the renewals, something that Kevin O’Donnell, President and CEO of RenaissanceRe commented on.

“I think there will be a combination of applying appropriate terms and conditions and appropriate pricing. Either way, margins are higher or lower because of either pricing or terms and conditions,” O’Donnell explained.

Grandisson agreed adding that “even though the expansion of coverage is not the culprit for losses, we can cut back our exposures.”

S&P Global Ratings also expects reinsurance pricing to increase at the start of next year, anticipating 0% to 5% of rate increase in global pricing at the January 2018 renewal.

McGavick of XL also noted that for many in reinsurance this will be the first time they have had to negotiate any price hikes, having only seen a steady softening in recent years.

“There’s a substantial issue in the way of progress: The inexperience of our workforces in the face of this type of market,” McGavick said, explaining that younger market participants have no experience in telling brokers that prices will have to be higher.

Whether that causes any friction at 1/1 remains to be seen, as some eager to place or underwrite business perhaps don’t demand the same rate increases as those wanting to see a true inflection point emerge.

The question remains on risk commensurate pricing though, as over the longer-term what is important is that pricing is commensurate with the levels of risk being assumed and held by reinsurers.

The market has yet to find a way to establish such a pricing benchmark, which given the continued inflows of capital and promise of much more flowing in over the coming months still suggests that price increases may be more muted than reinsurers want and much shorter-lived than they possibly should be.

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