Among traditional reinsurance players there still seems to be a tendency to believe that reinsurance pricing will bounce back just as soon as losses normalise, a view held by some of the largest reinsurers. Is this Ostrich syndrome, or wishful thinking?
Look back over the last few years and repeatedly companies have stated an expectation that reinsurance rates will rebound just as soon as we see a more normalised level of losses.
However opinions vary considerably on just what normal is, when it comes to loss activity that hits the reinsurance industry.
For some, normal is simply a year where we see an average level of catastrophe losses, plus an average level of losses in other lines of business, so simply what would be expected for a reinsurer to bear. There is a belief held that this, or perhaps two successive years of this, would see a reversal in pricing direction.
The largest reinsurers in the world hold this view still, which we feel has been messaging to shareholders that things haven’t changed, despite the disruptive forces that have been witnessed.
Others believe something more impactful is necessary to turn pricing, with some citing $100 billion loss years and the belief that this could turn pricing and revert the reinsurance cycle back to something more familiar.
Still more believe it could take a loss unlike anything we’ve seen before, something so impactful that a number of reasonably sized re/insurers fail due to the industry impact and the market is severely drained of capacity.
Scenario one, a reversion to the norm, is held by some of the largest reinsurers and here we have to ask whether heads are firmly wedged in the sand and ostrich tendencies being displayed.
The world’s largest reinsurers paid a significant share of losses in 2011/12, when the market experienced heavy losses and the resulting price increases ended up being relatively minimal and were soon erased.
The erasure of price gains in regions such as Japan, Thailand and other areas that had seen the highest price rises was in fact largely down to the major reinsurers, competing on price to retain risks in markets deemed key diversifiers. It was not the accelerated entry of ILS capital that softened these markets so fast, most of that capital flowed to U.S. risk.
A normal level of losses does not seem likely to reverse recent trends. A few years of normal may stabilise prices, but given where we are today with prices already considered to be bumping along the bottom, how sustainable would that scenario be for reinsurers? Likely not very.
Scenarios two and three, a year or two with industry wide losses in the $100 billion region and the much larger, as yet unexperienced level of losses, both seem more likely to result in some price rises, but the question is how sustained would they be?
Given the attraction to re/insurers from the capital markets and from equity investors as well it seems unlikely reinsurance would be drained of capacity for more than mere days, so the expectation of a much flatter price cycle with much smaller periods of price rises seems to hold out for all but the most extreme scenarios.
Extreme scenarios, those never witnessed or even contemplated (modelled) before, could revert pricing significantly, no matter how much capital there is in the market. Here we’re thinking a sudden steep rise in sea-levels, the disappearance of a large chunk of the U.S. west coast after an earthquake, or something else on the cataclysmic level of loss.
But then all bets would be off and the market would adjust to price in the new understanding that the risks they thought they were bearing were not the ones they really needed to worry about.
Risk commensurate pricing is how the market should respond to any loss event really. If something is deemed more risky than you previously thought then you charge more to bear it.
Payback is a totally different topic and one we feel is likely becoming antiquated in a world where capital is more fungible, flows more rapidly and can move into risk markets with liquidity. It’s also not really what a reinsurer should be getting paid for, it’s really their expertise and risk understanding.
The senior management of one major global reinsurer believes that the cycle hasn’t changed, that after a few years of price declines things will naturally revert to an upward cycle, as bearing risk becomes unaffordable.
This is the same reinsurer that underwrites property catastrophe risks in some peak peril regions at levels at or below expected loss (this is common).
Another management team of a major global reinsurer believes that the normalised loss scenario will be sufficient for prices to rise. They too underwrite in some regions at levels around expected loss, despite telling shareholders how they are pulling back where risk is no longer compensated by price.
Both seem hopeful at best, given the capital in the industry, the capital on the sidelines, the strategies being employed to ensure capital (both traditional and alternative) can enter more rapidly and easily and the fact players everywhere are now shifting to access risk from nearer the source, improving margins anyway.
But perhaps these reinsurers will just increase their prices and perhaps the market will follow and support that?
In fact that is quite likely and we could see stimulated price increases as major players say enough is enough, and smaller players follow suit as they are delighted for any chance to secure more risk at higher rates.
But these rises will be short-lived. In fact, it’s hard to see any scenario causing a sustained and persistent increase in reinsurance rates, at least to any level near where rates used to sit, other than the most extreme, unexpected, model changing and company damaging.
At the same time these major reinsurers are preparing themselves for continued softness. All the while they tell shareholders and analysts that they expect prices to revert to something more normal they are preparing for a new normal, a perma-soft reinsurance marketplace.
With risk becoming better understood all the time, as the tools, analytics, data and models are enhanced, while at the same time capital becomes more direct and fluid, access to risk moves closer to the source, and technology plays an increasing role in distribution, why would prices ever see the fluctuations that reinsurers enjoyed in the past?
We believe that we’re only scratching the surface of the potential use of capital markets money more directly in re/insurance and that as financial technology and advanced technology collide the acceleration of risk to capital is only going to increase.
There’s definitely an element of heads being in the sand in some quarters of the reinsurance market. Of course it’s possible that it’s been done on purpose, a PR ploy to drown out the noise while reinsurers work out a response.
The last significant, market-wide property catastrophe reinsurance pricing reversal was 2005 to 2006, according to the Guy Carpenter Rate-on-line index. In that year the index jumped 36%, but even that was terribly short-lived.
We haven’t seen anything like it since and, given where the reinsurance market is today, it seems far more likely that the pattern seen after that is the more likely pattern for the future.