Ed Noonan, CEO of global insurance, reinsurance and ILS capital management firm Validus Holdings, said that he believes the reinsurance market is approaching the bottom, in terms of pricing, but that the market is now primed for a correction.
“The global cat market is the most competitive we’ve seen in our time as a company. We believe 2015 will be the bottom, but we fear that the softening of terms and rates position the market for a massive correction in the event of a major loss,” Noonan explained to analysts during the Validus Group third-quarter earnings call, last week.
Reinsurers and ILS managers will be pleased to hear that the bottom of the pricing cycle may be nearing, however Noonan’s warning that the market could face a correction will be concerning to some, but debated by others who believe the reinsurance market cycle will not bounce back in the same way it has previously.
Noonan continued to explain; “It was only 3 years ago that rates in Japan had to double post event to attract the needed capacity and the broader market is now potentially primed for this type of large-scale post-event correction, particularly if the loss has surprising elements to it. It is always the unknown unknowns that cause a reset in industry risk appetite.”
The unknown unknowns are the risk that could be increasing in the market, due to the relaxation of terms and conditions, the adoption of more multi-year covers, the inclusion of more unmodelled risks and the bundling of treaties into single, large mega-treaties. This is the perhaps increasing risk that the market may face after a major industry loss event strikes, which Noonan is clearly concerned about.
While terms are being stretched pricing pressure is now moving beyond catastrophe risk, which Noonan sees as an unfortunate development of the current market trend; “The market is broadly too competitive with some, but not all, of the large generalist reinsurers seeming to be seeking market share with diminished discipline. The real pricing activity is moving away from catastrophe risk to everything else. It’s unfortunate because the market has had such strong discipline for the last decade.”
“There are no magical segments that are beautifully priced and the idea that a well-diversified portfolio of poorly priced risk makes sense is an economic capital model based fantasy,” Noonan continued.
At times like this it is important to double-down on discipline and not to follow the market downwards. Noonan commented; “All in all, it feels like a good time to remain defensive in reinsurance and focus on protecting our shareholders’ capital while waiting for the inevitable fallout.”
No one would dispute that the reinsurance market is beginning to near the bottom of the current pricing cycle, particularly for the property catastrophe lines of business which have seen the steepest falls. The question of how the big or unknown loss event affects the market is the one which is less certain and likely to result in more discussion.
Will the market follow traditional reinsurers pricing after an event, resulting in doubling of rates as has been seen in the past? Will insurance-linked securities (ILS) players and the capital markets set the pricing in post-loss markets of the future? Or perhaps ILS players will watch traditional reinsurers attempt to hike pricing but come in at lower rates to undercut and to take an increased share of the market after the next major loss?
Many questions and much uncertainty surrounds this, a lot of which will be driven by the type of loss scenario that we next see. As Noonan insinuated, this will also depend on just how much additional exposure the reinsurance market has been assuming, through the expansion of terms and the bundling and extension of covers, again a big unknown.
Some ILS managers we’ve spoken with said that they will, of course, expect to be able to raise prices after a loss event. However they all said that they would not expect to be able to hike prices as we have seen historically, with some even agreeing that the concept of payback and doubling or trebling of reinsurance rates post-event is perhaps antiquated.
How that will play-out alongside traditional reinsurers who may still want to hike rates significantly will be interesting to watch. Will the ILS players stick to this and undercut the reinsurers rate ambitions? Or will the ILS players see the allure of much higher rates and try to benefit from them as much as the traditional players? We’ll have to wait and see.