Risk-adjusted returns could increase significantly (for some)

While reinsurance and retrocession are heading full-tilt into a hard market in terms of pricing, the increasing focus on precision of wordings and terms are set to result in 2021 portfolios that could deliver significantly higher risk-adjusted returns for some.

Pricing is just one factor in delivering improved returns to shareholders of reinsurance companies, or investors in insurance-linked securities (ILS) funds.

As we’ve explained before, factors that play into overall returns for ILS funds in particular include the terms and conditions associated with reinsurance, retrocession and insurance-linked securities (ILS) contracts, as well as the way risk is accessed.

At the upcoming January 2021 reinsurance renewals, terms and conditions, so ultimately the contractual wordings of reinsurance or retrocession coverage, are likely to matter more than perhaps ever before and could be negotiated harder than ever as well.

The outbreak of the COVID-19 coronavirus pandemic has heightened risk aversion among the insurance and reinsurance community, as well as insurance-linked securities (ILS) investors.

It has also clearly evidenced the very real possibility that reinsurance and other risk transfer contracts can end up covering risks that were never envisaged, or priced for.

All of which has put the precision of coverage at the top of a list of priorities for many in the reinsurance and ILS market, perhaps as high, or even higher, than the ultimate rate-on-line charged.

Whenever we speak with markets about this upcoming renewal, they generally characterise it as one of the most important in years.

January 2021 is being seen as a chance to reset the product offering for many in reinsurance and ILS, an opportunity to clarify terms of coverage and ensure it’s transparently documented for both sides.

The goal is to both, have a more predictable return stream from portfolios of reinsurance, retrocession and ILS, as well as to reduce significantly the chance of unexpected and unwanted losses falling where they were never designed to be covered.

This is also one of the reasons the reinsurance market is currently seen as particularly attractive as well, for investors on both the traditional and non-traditional sides.

The clarification and cleaning up of wordings, terms and conditions, could have a significant impact on the ability of some players to improve their risk-adjusted returns, making for more stable return streams for their end-investors.

Hard markets always tend to be characterised by firmer pricing and tighter terms, as well as firmer pricing.

But this year the benefits to underwriting returns and ultimately margins, may flow just as much from the terms side, as they do from pure rate-on-line.

ILS funds had put considerable effort into improving the terms around their collateral in the last couple of years.

This extended through to quota shares as well, as buffer loss table clauses were renegotiated at the last few renewal seasons.

We can expect more of the same in January 2021, as collateralised providers of reinsurance capacity look to firm up those all-important collateral release and trapping related terms where they still need to be.

But more importantly, the precision of the coverage itself and the wording surrounding that, has far greater potential to improve the risk-adjusted performance of an ILS or cat bond fund as we move forwards.

Of course, terms tend to get stretched when the market softens.

We saw this in the early stages of the last decade, when reinsurance coverage terms, such as the hours clause, extended significantly to broaden the coverage that was offered.

Given the lengthy period of softening seen, some might be looking to roll back gains in coverage that were made. But it’s likely the focus will have to largely be on more nuanced areas of wording than the hours clause and similar broad coverage terms, that are now accepted in the market.

As a result, it is likely to be those who enter renewal negotiations with a clear vision for the coverage they want to offer that have the best outcome here.

Being able to clearly articulate why wordings need to change and the benefit to both parties in a transaction by doing so, is far more likely to result in the kind of meaningful adjustment that improves the return potential of your portfolio.

Not everyone will have the same outcome and we’re already hearing of preferential terms being offered to larger providers of capacity, which once again suggests a less than even renewal outcome is likely (both in terms of rate and terms achieved).

Wordings and terms have perhaps never been as important. The pandemic has demonstrated exactly why and now the market is responding.

Even Lloyd’s is taking steps here, with a call for a more simplistic approach to coverage, to ensure insurance products can be more easily understood.

That kind of approach can also benefit the other tiers of re/insurance, as simpler, clearer insurance products should naturally be bundled up and covered by simpler, clearer reinsurance contracts as well.

Of course, as the renewal approaches and competition ramps up, the onus on terms may lessen slightly in certain quarters.

But those who stick to their guns and look to recalibrate their portfolios to more precisely worded coverage, could reap the benefits in terms of returns over the coming year.

Our upcoming Prospectus 2021 conference will have a session specifically on the topic of T&C’s and the importance of precision of coverage. Register for free to attend.