Swiss Re Insurance-Linked Fund Management

Xactanalysis Insights and PCS

Memories are short, but paybacks can be long in reinsurance


The topic of underwriting discipline and whether it is being displayed in the reinsurance market has come to the fore once again at 2016’s renewals, as it becomes increasingly apparent some lines of business no longer meet everybody’s cost-of-capital.

The very large reinsurance firms, a few of which admitted to writing some business at negative or near-negative return levels earlier this year, can utilise this as diversification within their portfolios. Writing some business at below cost-of-capital just to maintain diversification, or to keep their foothold in some lower returning lines of reinsurance business, is common in the reinsurance market.

Balance sheets allow leverage to be used and globally diversified portfolios allow some lines, or regional perils, to be discounted while profits are hoped to be made elsewhere. The problems can begin when pricing is softened across the marketplace, as we see today.

But the longer this goes on and the more sustained the price declines, as well as the expansion of terms, across the broader market become, the greater the chances that this practice could come back to bite some underwriters even the very largest.

Underwriting reinsurance renewals at levels where the return generated cannot meet your cost-of-capital is one thing, but additionally there are concerns among some market participants that certain lines of business, or peril-regions, are being underwritten at levels even below modelled expected loss.

In fact some have claimed that there were cases at the last reinsurance renewal featuring European catastrophe programs where transactions have been marketed to reinsurers and insurance-linked securities (ILS) players using the third-party risk model that provides the lowest expected loss, resulting in very low pricing indications.

It’s natural for the market to try to squeeze every ounce of value out of its cost-base in the current softened reinsurance environment, but underwriting at ever less-profitable levels cannot continue forever.

At some point losses will emerge with the potential to adversely impact some companies more than others, as the level of discipline followed becomes more visible. In fact this may already be becoming more evident, as some companies pre-announcing losses in advance of their second-quarter results reports do appear to have suffered perhaps more than their shareholders had expected, according to analysts.

Still we hear of pricing levels below expected loss, on some accounts and programs, particularly the diversifying regional perils. Anecdotally this does appear to be happening less frequently now, thankfully, but it remains a feature of the market suggesting that discipline is still being stretched while pricing is so softened.

For anyone who has been in the reinsurance market for a decade or two, these practices raise questions about underwriters memories.

For as one senior executive, Craig Kliethermes, President & COO of RLI Corporation, said earlier this year, when discussing the need to maintain discipline, be responsible on terms and conditions, and be selective about where you elect to deploy capacity, “Memories are short, the paybacks are long in this business.”

If an underwriter has been deploying significant capacity into less than profitable business, even for the often valid reason of diversification, it can come back to bite. For those underwriting at near-negative returns just to maintain footholds in the market, or as a way to leverage diversity to compete harder, the bite could be deep.

For the ILS fund managers of the world it can be frustrating when business cannot be accessed due to extremely low rates-on-line. Many Japanese programs have moved out of reach of ILS fund managers return requirements, while European property catastrophe risks are nearing the level of return where the ILS market will pull even further back.

With minimum returns to meet for their investors and less globally or line of business diversified portfolios, ILS funds sometimes have to just step away.

But the main message from Kliethermes comment is that the market can soon forget its mistakes, as well as what the impact of really large losses can be.

Forgetting the issues that plagued reinsurers in the 1990’s or the fact Florida was repeatedly hit by hurricanes just over a decade or so ago could be a dangerous memory deficiency for some underwriting shops. Long memories pay off in reinsurance and it’s important not to forget the mistakes (and losses) of the past.

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