Accelerated rate hardening to attract start-ups to broad opportunities: A.M. Best

An accelerated period of rate hardening across a broad range of insurance and reinsurance market exposures is expected to attract start-ups, perhaps leading to a Class of 2020 if the “significant hurdles” can be overcome.

Rating agency A.M. Best warns that those seeking to form the Class of 2020 will need to meet its stringent requirements on rating assessment, as well as securing capital, the necessary regulatory approvals, all the licences required and building out their underwriting teams, as well as gaining market acceptance.

Given the challenges faced and as start-ups currently seem in their very early or formative stages, perhaps the current Class would be better aimed at 2021, as getting up and running any sooner with a traditional rated insurance or reinsurance balance-sheet may be challenging, especially under the shadow of Covid-19.

The insurance and reinsurance market is looking particularly attractive for investors and capital providers right now, A.M. Best explains, with the period of hardening seen to be accelerating, albeit perhaps only for a relatively short time into 2021.

This, alongside the fact investors are struggling for other mainstream opportunities at this time due to the pandemic and financial market volatility, has made it easier for re/insurers to raise fresh capital to take advantage of the current market opportunity.

It’s also resulting in capital coming into the sector to create new start-ups, with a number of well-known initiatives featuring luminaries from the industry being widely discussed at this time.

A.M. Best says rate hardening is likely to accelerate, at least in the short-term, as re/insurers deal with the losses from Covid-19 and continue to feel the effects of capacity constraints across pockets of the market, in particular retrocessional reinsurance.

Favourable trends and opportunities are being seen, which has led to capital increases at some firms, looking to capitalise on the rate environment.

But A.M. Best notes that, “The ease with which companies have raised equity – and the subsequent increase in share prices – likely reflects the absence of other opportunities for investors.”

Which raises the question about how dedicated to the sector investors really are.

A.M. Best continues to explain the capital raising dynamics, saying, “The risk and reward calculation posed by the insurance sector in a hardening market may start to look more attractive to existing and new investors, including private equity.

“But there is also increased speculation that capital is looking to support new company formations – keen to benefit from hardening rates and terms and conditions.”

There are benefits to starting afresh, of course, which A.M. Best highlights as related to having clean balance-sheets and no legacy, which is particularly relevant right now when many companies are strengthening reserves for U.S. casualty business.

There is also the significant unknown that is the potential tail of Covid-19, which at this stage little visibility of how long the pandemic could drive insured losses for and how impactful any future waves of infection and lockdowns might be.

Another positive is the fact that new re/insurers can begin their lives using modern technology, so aren’t encumbered by the type of legacy systems that many companies continue to battle with on a day-to-day basis.

Another factor in start-up opportunity right now is the insurance-linked securities (ILS) market, which has shown over the last two decades that it can marshal capital into reinsurance effectively and efficiently, perhaps negating the need for new traditional re/insurers to a degree.

A.M. Best says that it “expects further flows of third-party capital” but notes that the pace has slowed, as the ILS market and collateralised reinsurance vehicles deal with losses and trapped capital from recent years.

In addition, the longer than expected tails and loss development of catastrophe events like hurricane Irma Maria, the Calfiornia wildfires and typhoon Jebi, have “caused both investors and capacity users to pause and assess what changes need to be made in underlying agreements,” A.M. Best explains.

This may lead to “a more measured use of alternative capital structures going forward,” the rating agency suggests.

A.M. Best notes that, “the opportunities presented by the current hardening market potentially reach into much broader exposures.”

This makes it more challenging for ILS capacity to target all of the current upside in insurance and reinsurance, given its largely short-tail focused nature.

As a result, “Any new start-ups in 2020 are likely to focus on traditional insurance products, taking advantage of improving market conditions.”

Of course, it’s always likely that any start-up reinsurance company begins its life with a significant property catastrophe market focus, as the shorter-tailed, more modelled risks, can often provide a faster way to build an initial portfolio of risk.

Time and again it’s seen that start-ups, be that traditional or alternative capital based, end up writing catastrophe risks at very competitive pricing, simply as a way to get started.

That can have a pressuring effect on rates, as new capital is often forced to be the cheapest in the market, targeting instruments like ILW’s as a way to get going.

In 2020 this may be no different, for those start-ups looking to emulate already existing business models, or the business model of a luminary founder.

But there is also room for innovation and A.M. Best highlights the chance of technology driven start-ups coming to the fore, which given the edge this can provide may stand a better chance of generating the returns their backers are really looking for.