With retrocessional reinsurance capacity expected to be constrained at the January 2020 renewals, particularly collateralised from the insurance-linked securities (ILS) market, some reinsurers and in particular Lloyd’s players may have to rethink their premium growth plans, analysts have suggested.
This is because retrocession has been particularly cheap in recent years, while also providing increasingly expansive earnings protection, leading some companies to rely on it as a source of growth capital.
With that particular capital source now seen as limited, following the recent years of major catastrophe losses, as well as the disappearance of one major retro participant in the CATCo product, and now the impacts of current year catastrophes as well, some firms that have relied on retrocession may find their options for reaching targeted growth much more limited.
After the Japanese typhoons of recent weeks, in particular Hagibis, there is an expectation that even more collateralized retro reinsurance collateral from the ILS market is going to be trapped, as cedents set particularly conservative loss picks and reserves.
The resulting situation means that retro capacity will be even lower at January 2020 than it was a year earlier and while a number of large, traditional reinsurers have said they will underwrite some retro at the renewals where opportunities are deemed attractive, it is unlikely to be sufficient to fill the evident gap in the market.
At the same time, recent capital raises that have been reported for new collateralised retro ILS start-ups have not been going as well as hoped for.
At least one high-profile attempt to raise capital for a retro ILS start-up has reportedly been shelved, with others struggling to raise much in the way of capital, and some existing retro focused ILS players are also finding it harder to raise capital in the current climate.
We’re told some retro ILS specialists, even at the lower-risk end of the scale, now face entering 2020 with severely constrained capacity due to trapped collateral, which could even make some players a less viable concern going forwards. At least one retro focused ILS players is rumoured to be seeking new partners/backers as a result.
The retrocession market is seen as significantly challenged right now, given the three years of losses and perhaps more importantly now three consecutive years of trapped collateral, that has hit the sector.
As a result, aggregate covers that provide earnings protection are likely to be particularly difficult to secure for 2020, which means reinsurers that have relied on this are going to find that smaller catastrophe events can dent their results more severely.
Over recent years, reinsurers have benefited from cheap aggregate retrocession which has cushioned their earnings and enabled them to stay leveraged when it comes to premium growth.
With those aggregate retro products largely removed from the market, or now extremely expensive to secure, it’s hard to see reinsurers being able to continue to maintain their premium growth rates over the coming year and perhaps beyond.
Capital protection retro products remain available, albeit with larger deductibles and higher attachment points, although reinsurers are going to have to pay much more for this type of retrocession as well.
This dynamic in particular, the removal of retrocessional earnings protection in the form of aggregate limits from the market, may impact some players such as Lloyd’s syndicates and the more catastrophe exposed or risk concentrated particularly hard.
Analysts from Goldman Sachs recently said that they believe this dynamic, and the more limited availability of retrocession and ILS capacity in general, could constrain some reinsurers gross premium growth over the coming year.
Some reinsurers that have been leveraging third-party capital in-house, within sidecars and other structures, or entering into quota share retro deals with ILS investors, may also find it tricky to refill all of the protection they had in-force from these ILS facilities going into 2020.
We understand that some retro sidecars and private ILS quota shares are being looked at extremely closely by ILS funds and investors, as they seek to identify where performance has been lacking through the last few years.
Another factor that will influence how easy it is for reinsurers to secure their needed retro ILS partnerships for 2020 is how they have approached the trapping and holding of collateral.
Those that have been particularly aggressive to trap ILS capital, may be looked on less favourably than those that have sought to work closely with their ILS backers to ensure just the right amount of capital is retained in case of loss development.
What’s interesting however, is that while some traditional market players may find that the lack of retrocession capacity in general, the removal of the pillared product from the market, and the evaporation or high cost of aggregate retro limits, dents their ability to underwrite as much catastrophe exposed premium in 2020, this in itself may present an opportunity to ILS funds.
As ILS funds and other collateralized reinsurance players are typically focused on the concentrated peak exposures, they may be able to step in where some traditional players cannot.
We suspect this will result in much more interest in ILS fund-to-fund hedging and industry-loss warranty (ILW) trading over the year ahead, depending on price of course.
The retrocession market and the availability of ILS capital to service it is going to be a significant factor in driving market reinsurance conditions for 2020, it seems.
The market has got used to retro being abundant, affordable, flexible and available. But no more.
Because of this, there is a significant opportunity right now for someone to enter this market, likely with a new product that can meet the earnings protection needs of traditional reinsurers.
It will be interesting to see if anyone can fill this gap in the market over the coming months.
For now, the catastrophe bond market also promises to fill some of the gap, as reinsurers looks to the capacity that is clearly available in that securitized market for well-structured, industry loss and other triggered retrocession deals.
Update: Neon’s pull-back from property treaty reinsurance due to a mismatch in pricing between retrocession and its inwards business gave a perfect example of the potential impacts of a retro capacity crunch.