Fragile market, perhaps significant ILS capital trapping, to sustain rates – CS analysts

The reinsurance marketplace remains fragile after a number of years of subpar returns and more recent stresses, which is expected to help price increases continue into 2021, albeit at decelerating positive rate levels, according to equity analysts at Credit Suisse.

Having spoken with reinsurers and also insurance-linked securities (ILS) sector experts, analysts from Credit Suisse remain positive on the ability of market participants to continue securing increases on pricing into the renewals of 2021.

The fragility of the marketplace is the key driver for rates, as reinsurers and ILS players seek to get back to a more sustainable, over the cycle, level of pricing.

While rates were up around mid to upper single digit percent at the January 2020 reinsurance renewals, they have risen much more rapidly at the mid-year contract signings, with broad increases of circa 25% seen.

The momentum is likely to continue, although there are some factors that could change the outlook and are expected to mean increases will slow down somewhat, the Credit Suisse analysts noted.

Chief among these are the inflows of new capital into the market, as investors and companies seek to capitalise on the elevated pricing levels and double-digit returns that are available.

Next is the fact reinsurers are currently “throwing off earnings levels incrementally in excess of their costs of capital,” the analysts explain.

These two factors are likely to mean positive rate movements decelerate into January 2021 and beyond.

But further wildcards could also help to accelerate the pace, chief among which is the potential for more ILS capital to be trapped at the end of this year.

Credit Suisse’s analysts warn that the business interruption cases seen broadly in the United States and in some other countries have the potential to result in significant amounts of ILS capital and collateral being trapped.

In fact they estimate, at a minimum, as much as 10% to 20%, or somewhere from $9 billion to $18 billion of ILS capital could be trapped if insurers were to lose dozens of cases relating to business interruption, or were certain states in the U.S. to pass legislation making BI retroactive.

At the moment this seems a worst case scenario, although some ILS collateral will without doubt be held later this year given the ongoing uncertainty over the business interruption legal situation.

Forecasting how much is extremely challenging at this time, but it is likely to be in the billions if no clarity is gained by cedents on the BI situation before the end of this year.

Even in quota shares, syndicated collateralised sidecar reinsurance structures and private sidecar arrangements, where losses are shared pro-rata and the potential exposure to Covid-19 BI is likely to be high, it’s easy to envisage a few billion dollars of collateral being exposed to trapping.

That’s without even considering the much larger excess-of-loss collateralised reinsurance marketplace, where re/insurer cedents could be motivated to hold onto collateral beyond year-end if they still believe they face significant uncertainty over potential business interruption exposure.

But whether it could stretch to 10% to 20% of exposed private ILS and collateralised reinsurance or retro capacity is extremely uncertain at this time.

It’s also worth pointing out that ILS funds and alternative capital structures are shifting to more remote layers of reinsurance and retro programs, while tightening up their terms and conditions at this time. Meaning the legacy contracts written before the Covid-19 pandemic escalated may be the ones more exposed to this threat (which would of course include much of the 1/1 cycle renewals).

Catastrophe losses are another wildcard, in particular from the U.S. hurricane and Japan typhoon season, or another major peril such as an earthquake.

Each could cause further significant losses and trap further ILS capital, which would definitely provide further stimulus to the rate increase trend into January 2021’s renewal season.

Whether further losses occur, or BI proves a significant issue, there still seems plenty to motivate underwriters to push for a sustained period of firming this time around.

It’s going to be some more months before we get a clearer picture of the 1/1 2021 renewal rate environment though and this year, perhaps more than ever, we may see an increasing number of renewals pulling earlier as they seek to ensure the capacity is available at the best possible price.

This year could be another where the renewal dynamic only becomes fully clear later in the year. Which may motivate more cedents to come to market earlier and test pricing, before the main January 2021 renewals rush begins.