Reinsurance dependency not necessarily negative: Demotech

For primary insurance carriers, having a dependency on reinsurance during challenging years characterised by catastrophe and severe weather losses, is not necessarily negative, as it can be a critical in enabling prompt claims payment, rating agency Demotech has said.

Having an appropriate level of reinsurance protection in place should not be viewed negatively, as it is prudent practice, according to Demotech.

The rating agency views the ability of a carrier to pay its claims and support its policyholders as foremost and chastises others taking a shorter-term view.

Joseph L. Petrelli, President and co-founder, Demotech, Inc., explained, “For property insurers with exposure to catastrophes, they must secure an appropriate level of vertical coverage (how much reinsurance for an individual event) as well as a vibrant horizontal program (how many events in the season). They spend heavily on reinsurance.

“Demotech views the quality and quantity of reinsurance as a critical component of the carrier’s enterprise risk management program and business model.

“In contrast to our view, which recognizes an appropriate reinsurance program as prudent practice, other rating agencies may view this important expenditure negatively and characterize it as a dependency on reinsurance.”

Demotech notes the many challenges faced by U.S. insurers in recent years, including the impact of the COVID-19 pandemic, business interruption litigation, rioting and civil disturbances, severe convective storms, record number of named storms and hurricanes in the 2020 season, wildfire losses, and more expensive catastrophe reinsurance, with prices rising since 2019.

Despite these challenges, “Property insurers from coast to coast have been investigating, evaluating, and honoring property damage claims without missing a beat.”

Demotech says that it perceives the primary function of an insurance company to be its ability to investigate, honor or defend meritorious claims.

But it believes other rating agencies have taken a “short-sighted, quarterly earnings perspective,” of the insurance industry.

While some would point to a reliance on reinsurance as a potential weakness in business models, of course the industry has changed dramatically in recent years, partly due to reinsurance capital and pricing trends, with originate to distribute and fee earning insurer or underwriter business models gaining broad adoption.

Reinsurance has played a vital role in supporting insurers ability to pay claims in recent years and Demotech believes this shouldn’t automatically be perceived as a negative.

Petrelli explained, “In 2020, with the number of named storms in addition to other events, property insurers honored commitments to policyholders by addressing the claims that emanated from the named storms and events in addition to attritional claims.

“Rather than applaud these insurers for having reinsurance programs that facilitated their ability to pay claims and simultaneously protect their financial stability, other rating agencies seemed to be surprised that insurers could not earn an operating profit while addressing the undue number of claims emerging from the catastrophe events.”

Of course, reliance on reinsurance can be both a positive, where the underwriting remains profitable and so an insurer continues to earn decent returns, or negative where an insurer is effectively giving away all of the profits in its book and seeing a steady decline in performance due to lower underwriting performance.

But, as Demotech says, in the insurance market in 2021, reinsurance use should not be considered a weakness.

Rather, with reinsurance increasingly used as capital as much as protection, it can be a lever for growth and a buffer for performance, soaking up losses while offering a way to expand at the same time.

The capital markets and insurance-linked securities (ILS) has been a primary driver of the changed motives and strategies behind reinsurance, over the last two-decades or so.

It’s far more strategic now, with reinsurance strategies rarely clear-cut and often far more nuanced than they may first appear.