Reinsurers accepting broader terms likely to experience painful losses: KBW

The traditional reinsurance firms accepting broader terms and conditions, such as the inclusion of terrorism and cyber risk within property catastrophe reinsurance program renewals, are very likely to experience painful losses, in the opinion of analysts at KBW.

In a report discussing the results of Bermuda-based property catastrophe and third-party capital focused reinsurance firm Validus, analysts at KBW agree with Validus CEO Ed Noonan’s perception that some of the broadening of terms and conditions at recent renewals has been getting “out of hand.”

KBW said that it “absolutely agrees” that the inclusion of less well modelled and often totally unconnected risks such as terror and cyber risk in property catastrophe programs risked some traditional players leaving themselves open to suffering “painful losses.”

During Validus’ second-quarter earnings conference call, CEO Ed Noonan said that the most interesting observation in terms of the mid-year Florida reinsurance renewals was the fact that the market did finally start to push back when both rate decreases and the broadening of terms and conditions got out of hand.

Noonan said that there were a number of deals which had to be repriced, as quotes were retracted once the pricing was understood to be insufficient for the risk being transferred. This was true for both traditional reinsurers, said Noonan, as well as more surprisingly for ILS managers.

Noonan noted that while these low-priced, all-inclusive, deals are “eye popping” for the media, they are not the whole Florida market story and there are plenty of reasonably priced deals around, including Validus’ own book of risk.

Noonan said about the Florida market of today; “It’s an underwriters market and that plays to our strength, the ability to access data quality and accuracy through very deep analytics which allows us to identify the best risks among a declining pool of attractively priced business.”

Some of the broadening of terms, to include elements such as terrorism and cyber, resulted in split terms on placements, Noonan said. This likely means that while some markets were accepting of the broadening, others were not and the cedents had to either split the coverage among counterparties or opt to reduce its size.

These deals find the weak spots in reinsurers risk management, said Noonan, which only become apparent once the market suffers some big events, something that Validus is not willing to roll the dice on he explained.

Noonan said that the quoting process in the reinsurance market, particularly Florida, has “broken down.” Instead of brokers canvassing the market as to what would be acceptable in terms of price and conditions, they are just approaching the market with an offering and some are willing to take that risk on. Reinsurers are now pushing back on that approach, he said, as even catastrophe risk does have a capital charge associated with it.

KBW’s report does not go into anymore details on the issue of reinsurers putting themselves at increasing risk with the acceptance of ever broader terms, but it is a topic that concerns many in the market.

There is a definite tone of concern in conversations with those working with firms who have been broadening terms significantly, that they may have been taking on more risk than they should and in some cases risks that they do not clearly understand.

Cyber and terror are very difficult risks to underwrite as standalone contracts, but bundling them into a property catastrophe cover could be a step further than the market should go and this, as KBW and Noonan rightly point out, could come back to haunt those who accepted these risks just to get the signings.