In the future the reinsurance market will find it increasingly difficult to sustain price increases after major losses, as the ILS sector has made contingency plans to inflow new capital rapidly post-event, according to Guy Carpenter Vice Chairman David Priebe.
The reinsurance market has been softened due to excess levels of traditional capacity and the growing influence of and competition from alternative capital, sourced from capital market investors and deployed through insurance-linked securities (ILS) structures.
As a result, the reinsurance cycle may not be the same again and the peaks and troughs of the market price cycle may be significantly dampened by the availability of capital and institutional investors willingness to deploy more of it.
David Priebe, Vice Chairman and reinsurance broker Guy Carpenter, explains; “Historically, traditional reinsurers increase their premium rates after industry catastrophe events in order to replenish capital and attract new capital, with the goal of reaching overall premium rate adequacy and restoring returns on equity to levels more consistent with what is expected of equity capital.
“However, GC Securities has found that significant pricing increases will be difficult to sustain for short periods because of the inflow of new capital that typically follows catastrophe events.”
That suggests that while price rises may be enforced by the traditional reinsurance market, their impact may be short-lived and pricing may not rise even after much larger catastrophe events than we have seen lately.
The reason for this is investor appetite for accessing insurance-linked investment returns, from allocations to ILS funds, catastrophe bonds, collateralised reinsurance sidecars and other structures. As appetite has risen to a level greater than the available market opportunity, currently, capital is being lined up on the sidelines in readiness for the next deployment opportunity.
“Alternative capital is already making contingency plans with funds created so that they can inflow new capital rapidly post-event. The difficulty in sustaining price increases means that premium rate adequacy is even more critical in soft markets when capital is abundant,” Priebe stressed.
Traditional reinsurance firms may need to rethink this expectation of receiving payback, for having taken on and held clients risks. Historically, reinsurers would expect clients to pay them back for this, but if there is capital willing to continue underwriting the risks at lower rates, then clients will likely increasingly look to the more cost-efficient options available through ILS.
“(Re)insurers need to evolve by reassessing business models for more efficient allocation of risk to capital sources,” Priebe said.
Cory Anger, Global Head of ILS Origination and Structuring at GC Securities, explained some of the pricing dynamics that could enable ILS capital to sustain lower pricing for longer.
“The ability to lower minimum premium rates for remote high severity loss layers is affected by the continuum pricing level to risk level relationship across the entire risk transfer program in addition to the specific layer’s pricing to risk level ratio,” Anger said.
Going on to explain; “If the competition among risk transfer capacity sources results in all layers pricing lower, then alternative capital may be able to justify lower minimum premium rate pricing from prior levels.”
This is the lower for longer, softer forever, reinsurance market environment that traditional companies have feared. This needs a concerted response to reduce the traditional reinsurance cost-of-capital, find new profitable opportunities to underwrite risk, leverage technology to become increasingly efficient and a willingness to become agnostic as to capital source, by leveraging multiple balance-sheets, some of which may be collateralized by ILS investors and third-party capital sources.