The size and geographical reach of U.S. property and casualty (P&C) insurers contributes to companies’ reinsurance utilisation as a means of reducing volatility in underwriting results, highlights Guy Carpenter (GC) in a new report.
U.S. P&C insurers remain in a challenging operating environment, where ample capacity, benign losses, reduced reserve releases and seriously low interest rates are pushing down underwriting results for many in the space.
In order to reduce volatility firms utilise divergent volumes of the abundance of reinsurance capacity to produce more desirable and stable returns, a trend that GC has explored in a recent report.
GC explains that dependent on business lines, the size of the company and the geographical location/reach, differing volumes of reinsurance utilisation can be seen across the U.S. P&C sector.
Analysis from GC shows that “it is clear that for all lines of business analyzed, companies with higher reinsurance utilization have higher historic net and gross loss ratio volatilities than companies with lower reinsurance utilization.”
This is an interesting finding, and the firm explains that it is likely down to a number of factors, including the fact that larger firms typically purchase less reinsurance for certain business lines, and the sheer size of their premium volume and geographic diversification may contribute to more stable returns without the need for reinsurance protection.
Furthermore, U.S. P&C insurers that operate in riskier sections of any given business line might be more inclined to utilise a greater volume of reinsurance cover to smooth out any volatility in results. Thirdly, explains GC, for those companies that experience rapid growth, results can be more volatile than that of a more steady company, which typically sees the former be more heavily reinsured.
Of course it also suggests that those underwriting more volatile lines of business require and use more reinsurance capital, in order to smooth them out over the longer term.
“Whatever the cause, it is clear that companies that use reinsurance most heavily are expecting, and generally experience, significantly higher loss volatility than companies who utilize reinsurance less,” said GC.
It’s also worth noting that owing to the abundance of capacity from both traditional and alternative reinsurance sources, conditions in the space are more favourable to buyers. As a result, primary players can take advantage of efficient reinsurance protection and more favourable terms and conditions (T&Cs), a trend that could also contribute to the amount of reinsurance utilised by the P&C industry in the softening market cycle.
Typically, then, the companies that experience the greatest volatility with underwriting results tend to use more reinsurance to smooth out returns and ultimately reduce volatility, hoping to produce more stable and desirable returns throughout the operating year.
As an example of divergent uses of reinsurance within certain business lines, GC notes that reinsurance usage in workers’ compensation and commercial liability lines peaked between 1999 and 2002, which was during the peak of the last casualty hard market cycle.
From 2002 until 2009 the trend reversed explains GC, with ceded premiums declining as the casualty sector recovered and companies were, overall, better capitalised and therefore required less reinsurance.
“This degree of cyclicality in reinsurance utilization is largely a casualty phenomenon – property reinsurance utilization percentages have stayed mostly stable over the last two decades,” explains GC.
The business mix and size of an insurer, along with broader market cycle trends clearly impacts a firms decision on reinsurance utilisation, and it’s apparent that when utilised prudently the wealth of traditional and alternative reinsurance capital can help primary players smooth out volatility and achieve greater efficiency and more stable returns.
“The impact of reinsurance in volatility reduction is negligible for companies with very little volatility in their gross underwriting results, but reinsurance materially reduces that volatility,” says GC.