The UK’s Prudential Regulation Authority unit of the Bank of England has sent yet another warning to insurance and reinsurance CEO’s on the need to remain disciplined on price, especially while prices continue to soften, and that the alternative market continues to pressure rates, particularly in property catastrophe risks.
The PRA’s Executive Director for Insurance, David Rule, wrote to the CEO’s of insurance and reinsurance companies on the findings of regulators latest questionnaire for London re/insurance market participants.
Of particular note are comments on pricing adequacy, discipline and a suggestion that there are growing concerns that some companies may be taking on more risk than they are really accounting for.
Rule wrote; “The headline findings are another year of continued softening in premium rates and some evidence of widening in terms and conditions. However, our analysis also highlights a contradiction.
“In aggregate, premium rates reduced, but overall premium adequacy, as estimated by firms, is marginally higher. While we recognise that not all business can be subject to robust technical price, this observation does raise the question whether some firms are taking an overly optimistic view of current pricing.”
It is interesting that, for some reason, the surveyed re/insurers appear to believe they are pricing risk better, underwriting it more diligently, but pricing is declining and terms expanding, which of course suggests more risk being assumed for lower returns.
Under those circumstances you’ve perhaps believe re/insurers would say their price adequacy is declining too, but perhaps this signals a change in mind-set and a realisation that lower rates are here to stay and can be sustained. Or the re/insurers are being less than honest with themselves.
While rates are continuing to decline, the PRA found that this is moderating in the vast majority of lines of business, something that has been witnessed at the recent reinsurance renewals.
Terms and conditions are definitely widening, the PRA believes, but says that “views differ as to whether this is sufficiently material to raise risks overall.”
This does seem dangerous, that terms are being expanded and there is no widely held view of whether this is increasing risk or not. It suggests that the heads-in-the-sand mentality on pricing (that we’ve written about before) may be becoming increasingly widely held.
Perhaps most concerning though are the perceptions of rate adequacy findings.
The results from the questionnaire suggest that re/insurers believe profitability is being maintained, the PRA’s Rule explains, but he notes that this highlights a potential disconnect between the current view on pricing and assessments of Risk-Adjusted Rate Changes (RARC).
He writes that lines of business which are perceived to have the most favourable rate adequacy are the lines which are the hardest to model and the longer tailed lines where the cost of claims cannot be known for some years.
That really is concerning, as how can a line of business that is hard to model be known to have adequate pricing, unless of course the market believes it is knowingly and systematically overpricing the risk in order to account for the inherent uncertainty. Seems fraught with potential future difficulties.
Also of interest is the fact that new business is perceived to have better rate adequacy than renewed business, as this could be down to the whole ‘relationship’ factor of re/insurance where by a renewed contract perhaps gets some pricing benefits baked in, reducing the adequacy of the price in the eye of the underwriter.
Firms responding to the survey also raised portfolio underwriting, and facilities, as potential areas of concern where the price adequacy is less apparent, as well as new lines of business such as cyber, which also offer the potential for cross-class exposures to emerge.
Changing methods of distribution come up a fair amount, from facilities to delegated line-slips, but also MGA’s and digitalisation, are all seen to raise risks with respect to price adequacy among the firms responding.
This is perhaps a natural reaction from underwriting firms, to push back on those routes to market which can marginalise their ability to command the lions share of the margin.
Given the concern on the potential for risks to be underpriced in the London market has spread widely enough for Fitch Ratings to warn on Lloyd’s outlook, these insights on the perception of price adequacy in the market are quite telling and should help the regulator to hone its focus for the future.
Also of note to our readers is the fact that the PRA’s survey showed that at the January renewals, which see a significant amount of business renewed in the London re/insurance market, the area that softened the most, and actually saw a faster rate of softening than in the prior year, was property catastrophe risks.
Risk-adjusted rate changes for property catastrophe reinsurance at the January 1st 2017 renewal declined by around 8% in the London market, the PRA found, compared to around 7% in the previous year.
This steeper level of rate decline at the January renewal likely reflects “continued competitive pressures from alternative markets” the PRA said.
With Fitch having said in its assessment of the Lloyd’s market that it believes there is an increasing exposure to catastrophe risk there, despite declining margins over the last couple of years.
The PRA’s recent survey suggests that the price adequacy of this catastrophe risk underwriting continues to decline, which if London is overall assuming more of it, at lower pricing and with the broader terms the PRA cites, could be a bigger reason for concern should a major event occur.
Of course, perhaps underwriters are just more confident in their ability to price risks, the risk models they use, and the quality of their own underwriting?
Time will tell and those lacking discipline will be found out. The desire to continue underwriting at levels that can compete with the most efficient capital, business models and distribution channels, could be the Achilles heal of the sector.
Undisciplined behaviour has always come back to bite in reinsurance, and likely always will.
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