Basis risk of unmodelled losses needs pricing in: Conduit’s Eckert

In reinsurance, the impacts of unmodelled losses constitute a form of basis risk and after the last few years this has to begin getting priced in, according to Conduit Holdings Executive Chairman Neil Eckert.

Conduit Holdings is the parent of Conduit Re, a Class of 2021 reinsurance start-up that successfully launched after a $1.1 billion capital raise and an initial public offering (IPO) and listing before it had even underwritten any business.

Chairman Neil Eckert highlighted a key issue the industry faces in Conduit’s recent and first annual report, citing the recent unprecedented impacts of winter storm Uri as just the latest example of a catastrophe loss event where he believes a significant portion of the risk wasn’t ever priced in correctly.

Eckert sees the recent turning in direction of reinsurance renewal pricing, with firming evident across the majority of regions and business lines, as “the first proper market correction the industry has experienced since 2005/6 and possibly the best market conditions since the early 2000s.”

But he believes that the 2020/2021 reinsurance hard market is different to any he has experienced during his long and prestigious career in the industry.

There are two reasons for the persistent firming seen in reinsurance as being different this time around and it’s not, as seen before, because of any shock loss event, Eckert said.

He believes that the combined pressures of soft pricing, a series of catastrophe losses and the low interest rate environment contribute one reason we’re seeing a different market reaction today.

But secondly and perhaps more importantly, Eckert says that reinsurance rates are being driven from the ground up, rather than top down, with insurance firming having led to a reinsurance market reaction to this.

“It is encouraging to see a market turning willingly as a result of market discipline rather than a forced reaction to a sudden reduction of industry capital,” Eckert explained, adding that “I believe this is leading to a more sustained adjustment in the pricing of event risk, but is also leading to a continuing hardening across all lines of business in both terms and, most importantly, conditions.”

This is set to benefit the entire industry, he believes, and is also set to drive an increased awareness of the systemic nature of some risks and also the need to be able to quantify exposures.

“The 2020-2021 years could well be remembered as the years of the unmodelled losses as evidenced by Covid-19 and more recently winter storm Uri. The market will have to adjust to start pricing in basis risk of this nature,” Eckert said.

Importantly, Eckert does not believe that capital inflows are likely to stem the firming of reinsurance yet, explaining, “Our belief is that these raises are immaterial compared to the extent of recent underwriting losses together with the need for continued reserve strengthening across the industry, which will underpin the current hardening of terms and conditions.”

CEO and Chief Underwriting Officer Trevor Carvey also commented on the recent winter storm losses, saying they are, “A timely reminder for the market ahead of the key mid-year renewals of the need to factor in the increasing costs of so-called ‘secondary loss events’. The insurance losses arising from winter storm Uri are complex and will take a while to determine, but it would appear to be the costliest US winter storm on record. These ‘non-critical’ perils continue to demand their own premium and margin allocations, once again testing attrition versus peak zone exposures.”

There is an increasing realisation that certain elements of catastrophe and severe weather exposure may not have been adequately priced in, while tail exposures can often be outside of modelled expectations.

Of course, this has always been the case, but now the industry has access to significantly more data and more advanced technology, helping it to identify these kinds of basis risks that sit within insurance and reinsurance pricing.

As ever, we would point to the need for reinsurance pricing to cover loss costs, cost of capital, expenses and a margin, but covering the basis risk of unmodelled losses may take time and that suggests firming might be more persistent than previously assumed, as long as capital doesn’t build up too much in the industry.