Loosening of reinsurance terms & conditions ‘dangerous’: KBW analysts

As expected, the increasing trend for property catastrophe reinsurance firms to loosen terms and conditions at renewals, as they seek to compete in a market of excess traditional and growing third-party reinsurance capital, is set to come under scrutiny.

Analysts from Keefe, Bruyette & Woods highlight the terms and conditions issue, citing it as a growing risk to some firms in the reinsurance sector, in their latest report which looks back at first-quarter property and casualty insurance and reinsurance market trends.

KBW’s report suggests that the property & casualty insurance space has reached a turning point, both in terms of fundamentals and performance of company shares, citing ever-increasing pressure from third-party capital, decelerating pricing across most lines of business, reserve risks and volatile weather.

The analysts note that they do not see the whole sector as increasingly negative, rather there is a need for investors to choose which stocks to buy wisely in the P&C insurance and reinsurance space, with the fundamentals worsening on many firms.

Pricing is a key issue in KBW’s outlook for the sector, with rates broadly slowing or softening. Commercial line rate increases are slowing, specialty becoming more modest, homeowners set to decelerate more rapidly and property catastrophe pricing nearing a free fall, according to the analysts.

On property catastrophe reinsurance specifically, KBW’s analysts note the growing concern that the influx of third-party reinsurance capital has significantly shifted property catastrophe reinsurance market dynamics, with softening now also emerging on other lines of reinsurance business.

In KBW’s view, attempts by some reinsurers to ward off pricing pressure by loosening reinsurance terms, conditions and coverages are a dangerous and under-appreciated side effect of the pricing pressure in the market.

KBW’s comments are not broad-brush aimed at every reinsurer in the market, despite the majority relaxing some terms to a degree, rather they will be focused a little more narrowly at those which have loosened terms the most in order to secure business in competition with third-party capital and ILS.

This is a topic we expect to hear raised increasingly frequently as we move through the rest of 2014. The amount of risk assumed by some catastrophe focused reinsurers will have increased significantly, due to the relaxation of terms. Loosening terms such as the hours clause, or including perils once excluded, can open up reinsurers to larger losses should certain events occur. An increase in the underwriting of aggregate covers will also have left some reinsurers significantly more exposed to the occurrence of multiple, smaller catastrophe events than we have seen for a number of years.

Of course it will take the occurrence of some catastrophes to show who may have loosened terms and conditions further than advisable. Recent severe thunderstorm and tornado losses are mounting, the wildfires currently burning in California look set to cause insurance and possible reinsurance losses and the approaching 2014 Atlantic hurricane season may give some cause for concern.

Until we start to see combined ratio results for catastrophe focused reinsurers later this year that we won’t know whether any have been impacted by their loosening of terms and conditions and catastrophes that occur. KBW is raising this issue now as it is a factor that their investor client base would want to consider when analysing any reinsurers as potential investments.

The terms and conditions issue is one that is likely to be highlighted with increasing regularity, particularly if the upcoming mid-year reinsurance renewals see even more aggressive moves by reinsurers to maintain market shares or if we see a number of market impacting catastrophe events.