Retro capacity decline exacerbated by fear of COVID-19: A.M. Best

The decline in available retrocessional reinsurance capacity is being exacerbated by ongoing fears over potential losses related to the COVID-19 coronavirus pandemic, on top of the added issue of pre-emptive trapping of collateralised ILS capacity, according to the rating agency.

In a new report, A.M. Best highlights that COVID-19 has created a sense of fear in the reinsurance market that is causing more problems for buyers of retrocessional protection.

The rating agency explains how recent consecutive catastrophe loss heavy years have significantly impacted some of the collateralised retrocession markets and ILS fund managers offering retro coverage.

As a result, a large amount of ILS collateral was trapped due to these catastrophe years, which has dented retro capacity over the last year, having a significant effect on reinsurance renewal rates as a result.

“The retro segment was disproportionately affected by the fallout of the catastrophes, as evidenced by a significant reduction in capacity, which has driven the overall price increase in the retro market,” A.M. Best explained.

But, on top of this the rating agency adds, “The decline in retro capacity is being exacerbated by the fear of the impact of COVID-19.”

Of a roughly $20 billion global retrocessional reinsurance market, ILS funds and other collateralised sources supply around $15 billion to $16 billion of it, meaning that the trapped collateral issue is perhaps most evident and acutely felt at this tertiary end of the re/insurance market.

It’s not just the trapping of ILS capital either, there’s also the fact third-party investors have not been so keen to reload and deploy new capital after the recent loss years, which has made it more challenging for the trapped capital to be replaced this time around.

Despite all of the issues that have faced ILS and retrocession though, it seems to have taken the pandemic to drive real rate hardening through both reinsurance and retro.

A.M. Best explained, “Going into 2020, retro capacity was already strained but the situation appears to have worsened with the advent of COVID-19.

“The pandemic is yet another unmodelled and unexpected loss that the insurance industry has to contend with, on top of the losses from 2017-2019.”

The pandemic itself has driven an investor retrenchment into other asset class opportunities, while multi-strategy funds shed their catastrophe bonds and other ILS assets.

The net effect has been a further decline in ILS capacity through the first-half of 2020, leaving even less available for retrocession at this time.

This time around it seems it is uncertainty, partly related to the pandemic business interruption issue, that could further dent retro capacity in advance of the key January 2021 reinsurance renewals.

“COVID-19 has also added some uncertainty to the retro capacity conversation for 2021 renewals. During the early stages of the pandemic, ILS managers expressed confidence that they would not experience a deluge of business interruption payouts. Over time, however, as managers have conducted more thorough analyses of their contract wordings, a more nuanced interpretation of possible outcomes has emerged, which could affect whether retro capacity will still be severely constrained, or whether traditional and ILS reinsurers will be able to provide the market additional capacity at reasonable prices.

“When all the catastrophe- related losses are tallied, some of the trapped capital may prove to have been unnecessary. Nevertheless, the trapping of capital, however temporary, disrupts the ILS reinsurance pipeline,” A.M. Best said.

Uncertainty and the pre-emptive trapping of ILS collateral, so before the buffer-loss table stipulations kick-in and as the pandemic is considered an ongoing event, is likely to drive issues for some ILS players later this year, where the exposure to the pandemic is deemed greatest.

Some other ILS funds though, especially those who write more named peril business, may avoid the worst of this and be especially well-positioned for the 2021 renewals as a result.

But, “Overall, the combination of uncertainty regarding the resolution of potential litigation and pre- emptive trapping will further constrain the supply of ILS capital and will particularly continue to squeeze the supply of retro capacity, which was already reeling before the pandemic,” A.M. Best said.

Capital raising is set to be key in defining how the retro landscape looks at 1/1 2021, with those able to raise capital set to benefit from much higher pricing it seems.

Demand is also set to rise, A.M. Best believes, with catastrophe bonds an area that could benefit as there seems a greater ability to raise new funds for the cat bond strategies, than for collateralised reinsurance, at this time.

How new retro capital flows in, whether to funds, cat bonds, sidecars, or traditional reinsurers, could be very different over the coming months and we could see some traditional players taking much bigger retro bets into the January renewals, especially if the rates harden as much as expected.

A.M. Best concluded that, “The winner of the retro sweepstakes will be traditional reinsurers with multiple outlets for deploying capital, as well as ILS funds that have demonstrated their ability to navigate through the extraordinary circumstances the insurance industry has faced the past few years.”