Price inadequacy of longer-tailed lines mean ILS could take a closer look

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The reinsurance market is expected to take a much closer look at the adequacy of pricing and profitability for many longer-tailed lines of specialty and casualty business, especially as reinsurers have generally been unable to command the payback they may once have been used to, following the catastrophes of 2017.

This could make it an attractive time for the insurance-linked securities (ILS) market to take another look at longer-tailed risks, as there may be an opportunity for the efficiency of ILS capital and benefits from diversification to be put to work in some cases, helping ILS funds to benefit from areas of the market that are expected to see ongoing rate increases.

Reinsurance firms had in the main been expecting much larger rate increases at the renewals so far this year, after taking significant losses in 2017.

But the renewal seasons so far have seen rates increase only slightly, with many accounts renewing flat and only the main loss impacted regions experiencing upticks in pricing.

Meanwhile the outlook for 2019 now looks likely to be a return to softening reinsurance prices, unless there are major losses through the 2018 hurricane season.

This inability to secure the rate increases hoped for in catastrophe lines, has driven some reinsurers to apply more upwards pressure to other lines of business, according to analysts at Keefe, Bruyette & Woods (KBW), who feel reinsurers have taken another look at underperforming lines of business.

“We think last year’s catastrophe losses unmasked other reinsurance lines’ overall price inadequacy that is now driving up those lines rates,” KBW’s analyst team explained.

As a result, reinsurers which are more diversified or have less concentration into property catastrophe risks, are generally seen as more insulated from the pressures of insurance-linked securities (ILS) competition.

But if reinsurers are successful at pushing up rates in longer-tailed casualty and specialty lines of reinsurance, that is only going to make it more attractive for ILS markets to continue their efforts to find solutions that allow them to invest in longer-tailed lines.

There are an increasing number of ILS funds and investors that are attracted to specialty and casualty lines. While investment in these areas of reinsurance remain far smaller than those into property and catastrophe risks, they continue to be a feature of the market, and the better the pricing looks, the more interest these areas can be expected to receive from third-party capital.

KBW’s analysts also believe that the run-off market is experiencing “a legitimate hard market” making it increasingly attractive to reinsurers with the expertise to take on closed portfolios of legacy business.

But again, the run-off market is an area that institutional investors are already attracted to and ILS investors extremely aware of the opportunities, which should ensure that any hardening of this market is only going to make it more attractive to create innovative structures and partnerships that allow ILS investors to fund run-off portfolios.

This is a conundrum for reinsurance firms these days, as any area of the market where they can force through rate increases could well become a fresh target for the ILS market. Or at least for institutional investors with broad enough mandates and the ability to work in partnership with others to extract the returns from the portfolios of longer-tailed or run-off risks.

It’s also worth considering the underperformance of the Lloyd’s syndicate market, as certain lines of business are certainly not enabling players to make returns commensurate with their costs of capital and rates will at some point have to rise.

If there is an appetite and an ability, through the new diversification it can generate, for ILS funds and investors to come in and back these risks with a lower cost-of-capital we could see more of a wholesale move into that specialty re/insurance market as well.

This all suggests there may be nowhere left to hide for traditional companies, with their only options being to modernise, become more efficient, find ways to leverage third-party capital in areas of the market where returns do not meet their own costs-of-capital, and focus on the areas where they can get paid sufficiently for their expertise.

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