Opportunity for reinsurance & ILS to mitigate casualty market headwinds

Reinsurance capacity and in future the depth of the ILS and capital market could be required to support casualty insurers against a growing number of industry headwinds, supporting the needs of a pressured sector while expanding the reach and influence of ILS capital and structures.

Global reinsurance brokerage JLT Re notes the importance of casualty insurers’ ability to hedge against increasing pressures in the sector, stressing the value reinsurance strategies bring to companies during times of market turmoil.

“Casualty insurers are facing many issues at the moment and while some think there will be ‘lower for longer’ interest rates which is a key issue for insurers, political uncertainty creates some doubt on the ‘lower for longer’ theory. The outcome of the US presidential elections could have an impact on rates. This would create a two-pronged effect of reducing the value of the bond portfolio and having a longer exposure to those same declining assets,” said Ed Hochberg, Chief Executive Officer (CEO) of JLT Re, North America.

On top of this, JLT Re cites uncertainty surrounding reserve developments as a further challenge that could add increasing pressure to casualty and liability rates.

In order to mitigate the impacts of falling reserves and wider casualty market pressures, JLT Re highlights the importance of reinsurance strategies, which could also be supported by the pool of alternative reinsurance capital.

“The good news is that uncertainty around reserve adequacy, together with interest rate and inflation risk, can be hedged by the strategic use of reinsurance. For example, structured reinsurance transactions can relieve long-term capital requirements for casualty lines in a low-return underwriting environment. With new investments generating less than a 2% yield, the opportunity cost is very little, if any at all.

“Working layer excess of loss reinsurance also provides a useful hedge. In a rising interest rate environment, medical inflation in excess workers’ compensation layers has historically been pushed significantly higher than underlying interest trends. Evaluating these layers based on overlaying medical inflation trends would be prudent,” said Greg Holtmeier, Head of Casualty at JLT Re, North America.

We’ve discussed previously at Artemis how reduced returns in the property catastrophe space and heightened competition has increased the desire of reinsurance and ILS to enter new, diversifying and potentially higher yielding business lines, such as casualty.

The reinsurance marketplace remains awash with capital from traditional and alternative sources, which are both looking for ways to boost underwriting returns in a low interest rate environment that has diminished revenue on the investment side of the balance sheet.

Others in the re/insurance and ILS space have noted the desire and ability of ILS capital to enter the casualty market, underlining that pension funds, which are key players in the space, can have lower return metrics and longer duration investment appetite.

Essentially, further deterioration of rates and additional pressures in the casualty operating environment could see more reinsurance required and, where reinsurance plays often ILS capital follows in some form or another.

Both the reinsurance and ILS space are in search for business outside of the highly competitive property catastrophe space, and it’s been noted a number of times during the softening cycle that casualty could become disrupted by alternative reinsurance capital.

“The political and economic uncertainty that dominates the operating environment makes forecasting key financial and macroeconomic trends a challenge, especially for a line of business that requires pricing based on long-term assumptions. This is particularly true for interest rates and inflation, which are key drivers for casualty lines of business,” continued Holtmeier.

Casualty players could benefit from utilizing reinsurance and ILS capacity to hedge the perils of a challenging landscape, taking advantage of the abundance of efficient capacity that’s currently in the global reinsurance market, exacerbating the softening cycle.

Previous analysis and market commentary suggests that ILS is unlikely to have the same kind of influence on the casualty arena as it has done in the property catastrophe sector.

However, as modeling and analytics continue to improve all the time and should investors show comfort and acceptance of the casualty space, it could play a vital role, alongside reinsurance, in hedging against the weak operating environment.

There’s an opportunity for the ILS space and the traditional reinsurance players to expand into the casualty arena and possibly achieve more desirable returns than have been on offer in the property catastrophe space as of late. The opportunity also lies with the casualty insurers, who could take advantage of the efficient reinsurance market in order to navigate the testing times.

Join Artemis in New York on February 3rd 2017 for ILS NYC