Primary insurance carriers are facing rising reinsurance costs and rating agency A.M. Best warns them to expect this to become an added pressure to their earnings, but not to increase their risk profiles by using less of it.
While the insurance industry has been profitable in recent years and many primary areas of the market are seeing rate increases, the addition of costs to the reinsurance protection many carriers have become reliant upon risks upsetting the equilibrium many have found.
In recent years, insurance carriers in the United States have benefited from an abundance of extremely well-priced reinsurance capacity, helping them to build larger, better structure reinsurance towers and to leverage reinsurance capital as a tool to support their continued growth.
Now, after a number of consecutive loss years, reinsurance carriers are looking to return pricing to what are seen as more sustainable levels, demanding higher rates in many loss affected areas and from loss impacted accounts.
A.M. Best warns U.S. primary personal lines carriers that this is one of the key factors that could pressure the sector in the year ahead, even though catastrophe losses have been more benign across the U.S. in 2019.
A rise in non-weather water claims has also become an added pressure, for the homeowners carriers in coastal and affected regions. Some of the areas where reinsurance rates are expected to be rising at their fastest at renewals in 2020.
A.M. Best maintains a positive outlook for the U.S. personal lines insurance market, but reiterates that the long-term favourable trend in reinsurance pricing is now over for carriers.
Commercial carriers are facing a similar trend, as rising reinsurance costs and the squeeze on alternative sources of reinsurance capital, are already having an impact on rates in commercial property and other lines, as carriers face up to higher cost protection.
Carriers have developed comprehensive vertical and sideways reinsurance program coverage and the abundance of reinsurance capital (traditional and alternative) has enabled them to grow coverage and use that capacity as growth capital at the same time.
Things are changing though.
“We are now seeing more demand from reinsurers in terms of price increases and tighter terms and conditions, as they look to limit their own concentrations,” the rating agency said.
Adding that, “Rising reinsurance costs have the potential to pressure operating performance as well as balance sheet strength, should reduced levels of reinsurance protection result in higher net probable maximum losses.”
The risk could be greatest to those primary homeowners carriers that are making use of reinsurance capital to support their own growth, as their enlarged risk portfolios will now require servicing with renewed capacity each year.
Without which they could face having to shrink, something no growth-hungry insurance carrier wants to do.
As insurance carriers have become much more savvy at exposure management and the interplay of reinsurance capital alongside their own balance-sheet in recent years, helped by the lower cost of coverage, they are largely better educated on how to source the most appropriate reinsurance capital at the best price as well.
As reinsurance pricing rises, we could see carriers becoming more experimental with their reinsurance program structures, looking at how to bring alternative and third-party capital more directly into their capital stacks, with initiatives such as primary sidecars perhaps offering the short-tailed focus an opportunity to secure reinsurance capital at a more reasonable cost, on a partnership and fee earning basis.
Importantly though, A.M. Best says that alternative capital “appears to be lining up with the traditional reinsurance market in seeking higher prices.”
It is this cross-market push for higher rates that seems set to install a new floor on reinsurance pricing, at least a couple of notches higher than we’ve been used to over the last decade.
This higher pricing floor is going to make reinsurance products once seen as perhaps more costly, or requiring more effort, appear more attractive again, which is currently being seen in the catastrophe bond market with some new quoting going on from companies that are less familiar with the space, we understand.
We’re also told by brokers that enquiries on how to bring insurance-linked securities (ILS) investor capital more closely within the capital structure of a primary carrier are increasing as well, as carriers begin to realise that they may need to more closely embrace alternatives to keep their reinsurance programs filled at reasonable pricing.
The dynamic of higher reinsurance pricing could also drive increased urgency to look at technology based ways of placing reinsurance programs, also highlighting the importance of efficient syndication and execution as well.
Carriers are going to be looking to the cost-of-capital and how they can reduce transactional costs, in their reinsurance programs, which promises to raise the profile of some technology initiatives and also the capital markets as efficient sources of execution and capacity, we believe.