Reinsurance “hard market phase” a cat bond market opportunity?

Reinsurance is now in “a hard market phase” across much of the market as the major players need to protect their earnings and capital against the still potentially unknown losses that could arise from the Covid-19 pandemic, according to analysis from Fitch Ratings.

Explaining why the market has hardened so quickly this time around, rating agency Fitch feels that it is a fear of the unknown, as the coronavirus pandemic piled on pressure for reinsurers and reinsurance capital providers, on top of issues related to increasing claims costs, caused by social inflation and climate change.

The fear is real and tangible in reinsurance, as the true size of the impact of the Covid-19 pandemic to reinsurer balance-sheets and also ILS capital providers may not be fully understood for some time.

Those exposed to longer-tailed lines of casualty exposure that cover employees and businesses face a particularly uncertain time, because as yet we have no visibility of the potential for a tail of claims to develop from the coronavirus pandemic and how that could affect the industry.

The backdrop of threats faced include, “potential unknown losses arising directly from the pandemic, adverse reaction of the capital markets to any further major waves of the virus and any additional major loss activity,” Fitch Ratings explained.

All of which has come together to drive the most sustained reinsurance price hardening seen for some time and across the broadest range of lines of business seen perhaps for even longer.

Uncertainty is a watchword.

While major reinsurance firms have tried to estimate their total costs from the pandemic, in reality there is significant uncertainty across estimates of Covid-19 claims and IBNR reserves, especially as so far we have no clear visibility of the extent of any claims flowing from liability lines due to the pandemic.

Where there is significant uncertainty, at the same time as pressure on capital and fear of second-waves, as well as how they could be treated under reinsurance, there is the potential for a prolonged period of hardening of rates, it seems.

Some might say that rates are only just becoming more commensurate with the recent history of loss costs and catastrophe frequency, not mentioning the much-discussed issues in certain areas of casualty reserves. All of which again suggests there could be further for rates to run, at least in some areas of reinsurance.

Prospects for investment income for the major reinsurers also look bleak at this time, with interest rates set to stay lower for even-longer, adding another pressure that should force them to look to generate more profit on the underwriting side of their businesses.

Fitch explains the current state of play as, “The widespread desire to protect earnings from pandemic-related claims and lower investment income has led to a more disciplined approach. Even before the pandemic, price adjustments were needed to reflect higher natural catastrophe claims and concerns over reserve adequacy and loss severity in casualty business line.

“Any additional large losses in 2H20, whether caused by man-made catastrophes, such as the explosion in the harbour of Beirut, or natural catastrophes, such as a hurricane hitting the US coast, will erode profits even more and as a consequence accelerate price improvements further, Fitch believes.”

Major reinsurers have been particularly exposed to the pandemic, given their broad underwriting portfolios include many of the most-affected areas of the market so far, such as event cancellation and travel insurance.

The property business interruption question and litigation remains a key one for the reinsurance market, as any deluge of claims from this area is almost certain to prolong the hard market even further.

While we might say, at this stage, that lower-cost alternative capital, from insurance-linked securities (ILS) fund managers and other capital market sources, could come in and keep rates from firming as much as they could have, at this stage it seems the ILS market is supportive of the hardening experienced to-date.

ILS capital faces many of the same pressures, as well as the pressures already layered on by the last three years of major catastrophe losses.

In addition, the ILS market faces the threat of more trapped collateral, due to ongoing uncertainty over pandemic related business interruption and the potential for that to push claims through into re/insurers catastrophe reinsurance and retrocession programs.

Add to this the fact that all of the uncertainty faced by re/insurers is amplified down the line to the ILS markets that provide them with quota share protection, sidecar coverage, collateralised reinsurance and retro, as increases to the ultimate losses of the major re/insurers will no doubt drive more losses into the ILS market as well.

So there is a significant reason to suspect rates will sustain at harder levels this time around, at least until the uncertainty over the size of losses from the pandemic subsides for the re/insurance market.

One area that may stand to benefit from all of this is the catastrophe bond market, which relatively untouched by the pandemic, except in terms of capital market dislocation, is ready to supply capacity that’s required should more re/insurers look to securitised, multi-year solutions for their reinsurance and retro.

In fact, there could be an opportunity for the cat bond market to present a more competitively priced product offering, during the current hardening reinsurance and retro market phase.

As the year progresses we may see more sponsors looking to cat bonds if the ILS investor cost-of-capital can really demonstrate the efficiencies that capital markets have always promised.

Cat bond market capital has been unaffected by claims from the pandemic and faces no threat from Covid-related issues including business interruption.

As a result, the cat bond market stands to face increasing investor interest over the rest of this year and into 2021, meaning the opportunity to become an increasingly important source of multi-year protection for re/insurers is clear.

At a time like this, when the traditional market is awash with fear and uncertainty, the cat bond market could find a time to shine, making the coming months perhaps an opportunity for some competitive ground to be gained.

Of course, any competitive dynamic will be met by the major reinsurance players. But with some of these also destined to use the catastrophe bond market for their own retro, perhaps a more balanced, symbiotic level of competition can emerge.

A broadly hardening reinsurance market seems like just the right time for innovative players to test the best mix of protection and long-term, multi-year capital markets coverage may look especially attractive right now, when supportive and hedging capital is required to allow traditional players to take full-advantage of the firming rates.