Reinsurance to bear brunt of Australian flood losses: AM Best

Reinsurance capital sources will bear the brunt of the losses from the recent severe flooding in Australia, with primary insurer retention expected to be relatively minimal, according to rating agency AM Best.

However, the effects of this will be continued upward pressure on reinsurance pricing and terms at the Australian insurers next renewals, AM Best believes.

“Insurance costs associated with natural catastrophes is generally subject to demand surge inflation, resulting from a localised increase in costs of labour and materials to rebuild,” explained Yi Ding, senior financial analyst, AM Best. “Prices of building materials are already at inflated levels due to supply-chain slowdowns and as demand intensifies in the aftermath of COVID-19-related lockdowns, as well as historically high oil prices and commodity shortages prompted by the conflict in Ukraine.”

The rating agency said that, “While the flooding should have limited impact on primary insurers’ balance sheet, insurers may find higher pricing and tougher terms and conditions in subsequent reinsurance negotiations, which could place negative pressure on operating performance.”

Australian property insurers tend to purchase catastrophe excess-of-loss reinsurance with a limit above an expected 1-in-200-year loss, driven by national regulatory capital requirements, AM Best said.

This flood event is expected to see losses fall well-below this threshold, but it’s also important to note that the total net exposure of direct insurers will in part be driven by their reinsurance contract terms.

Elements such as the hours clause, which stipulates the reinsurer will cover all the financial losses accumulated in a defined number of hours, are going to be important here, especially with flooding having been ongoing over a long period and a second flood event occurring last week.

“Treating the flooding as multiple events based on the hours clause could lead to significantly higher net cost or increased utilisation of annual aggregate reinsurance programmes for direct insurers,” AM Best said.

In the majority of cases it seems aggregate reinsurance utilisation will be key in minimising the impact of multiple flooding events for the major Australian insurers.

Given the trend of losses from severe weather, flooding and other catastrophe perils such as bush fires in Australia over recent years, AM Best expects there will be “an increased focus by (re)insurers on understanding, controlling and mitigating climate risk.”

It’s also notable that AM Best is warning that inflationary factors may exacerbate the eventual claims burden from the flooding, with demand surge and inflation related to high oil prices and commodity shortages prompted by the conflict in Ukraine expected to have an effect in pushing up claims costs.

Claims from the flooding in February had already been put at around AU $2.5 billion by the Insurance Council of Australia, but with additional flooding later in March as well, the industry loss that faces reinsurance providers with exposure is likely to be rising.

We’re told some insurance-linked securities (ILS) funds hold exposure to aggregate contracts covering Australian perils and that this is expected to dent some ILS fund returns a little for February, with some others expected to feel an effect from this in March.