Strong reinsurance capital. Disciplined providers. What’s next?

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Global reinsurance capital, from across traditional and alternative sources such as the insurance-linked securities (ILS) market, is particularly strong at this time, but rating agency Fitch explained in a new report that providers of it remain disciplined in their deployment of it.

question-mark-questions-reinsurance-ilsTypically, when global reinsurance capital levels have been high it has led to an almost inevitable softening of the market, but recent renewal rounds have shown a much greater level of discipline on all sides of the market, resulting in rates holding up better than before.

There are many drivers of this, including by the shocks caused by catastrophe losses over recent years, the ongoing effects of social inflation and loss creep, as well as the significant loss effects of the COVID-19 pandemic, the effects of inflation and low-interest rates, and a looming fear that climate change may drive higher losses over the years ahead.

All of which has raised the need for underwriters to cover their loss costs, cost-of-capital, expenses and a margin, which now seems to be driving a renewed understanding of what rate adequacy really means.

The reinsurance market and insurance-linked securities (ILS) capital providers, have long-needed to put a floor under rates, to ensure they are covering their outgoings over the longer-term.

Of course prices can’t just keep on rising and we’ve seen a deceleration in reinsurance rate increases at the mid-year renewals this year, but still underwriters and management teams have a much greater determination to keep rate adequacy in the market in 2021, it seems.

Better margins are now flowing through to those underwriting houses, with return per-unit-of-risk higher than it has been for a decade in some quarters.

In a recent report, Fitch Ratings commented on reinsurance market conditions, saying, “The June and July 2021 renewals were characterised by a slowing price momentum compared to January and April, as there was sufficient reinsurance capacity and profitability of the sector had recovered to strong levels.”

Importantly though, despite capacity being high and profits being attractive, “Both traditional and alternative capital providers remained disciplined and partially cut capacity for unattractively priced risks such as Florida windstorms,” Fitch explained.

Reinsurance underwriters, be they traditional or alternative (ILS) in their backing, face a changing global market right now, with pressures to elevate their own sustainability, as well as the sustainability of their underwriting profits.

ESG (environmental, social, governance) factors are adding new requirements to reinsurers business models and also in time are set to eliminate certain once profitable areas of their businesses, providing another motivator to keep disciplined and not drive down rates.

Climate change is rising up the agenda, not just in reinsurance, and it’s becoming increasingly hard to justify lowering rates on risk exposed to climate catastrophes, especially when share holders and investors are often among the most focused on mitigating climate risk and cleaning up businesses from an ESG standpoint.

In fact, the interplay of climate and ESG with investor activism is going to provide a new challenge for those deploying reinsurance capital, as should you take an outsized hit from climate related loss events, while at the same time talking up your ESG and climate-positive credibilities, the scrutiny your custodianship of capital will likely come under could be significant.

Which may provide another, tangential, motivator for not depressing rates and for installing a true pricing floor, that allows climate-related loss costs to be covered by the industry, as best it can.

There is perhaps more reason than ever before for reinsurance capital providers to ensure their discipline on pricing remains and these factors driving discipline seem unlikely to wane, at this time.

All of which means that the industry is going to have to strive to shave more points off the costs of doing business in reinsurance and accessing reinsurance capital, as efficiency (of operations, capital, expenses) is going to provide a lever that will allow competition on price to be achieved, while still maintaining discipline.

Which is where reinsurance gets interesting again. As players settle into a new market environment where covering loss costs is critical for their own reputation as custodian of capital, but there is still a driving need to be able to deploy that capital as efficiently and effectively as possible, to compete with the opposition.

Meaning that the efficiency levers are going to be out in force.

Be they cost-of-capital, operational, transactional, expense focused, and even market structure related, leaving reinsurance ripe for another accelerated phase of disruption over the next decade, as companies realise they need a new edge that doesn’t put their underwriting and capital custodianship prowess at risk.

Discipline is much-needed in reinsurance, but so too is an ability to gain an edge over competitors. Which promises to make for an intriguing market-landscape over the coming years.

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