1.1 Renewals Report 2022: Turbulent Waters
Perhaps the most telling aspect of this season’s important 1.1 reinsurance renewals, before we drill down into the dynamics of pricing or examine the myriad socioeconomic pressures being brought to bear on cedants and reinsurers alike in a fascinating market, was this: they were late, and in many instances, renewals of programmes really went to the wire. As Gallagher Re notes in its commentary, this was “a year-end renewal season notable for its protracted and late negotiations”, a sentiment widely echoed in the market, with Howden’s head of analytics David Flandro noting that “a host of factors contributed to unusually late renewals this year, with 11th hour secondary perils complicating the process further”.
In many respects, the simple fact of such lateness tells its own story: this was a challenging renewal in which reinsurers, buffeted by the winds of high catastrophe losses, inflation and continuing uncertainty over the development of COVID-related claims, understandably sought improved pricing while cedants, especially those with respectable loss ratios, were equally keen to resist “One of the things you are getting is a mismatch between buyer expectations and the need for reinsurers to improve results,” says Mike Van Slooten, head of Business Intelligence of Aon’s Reinsurance Solutions division.
“Any upward pressure on pricing is not really being delivered by a shortage of capital, which is what’s different about this situation relative to what we have seen previously. It is being driven by the need to improve earnings, and there are various reasons why earnings have been under pressure. Certainly, nat cat activity over the last five years is pretty high up the list, and 2021 is going to be another year with over $100 billion in nat cat losses across the industry – and the reinsurers have certainly picked up their share.”
“You have the continuing impact of COVID, on top of nat cats, so the market has taken $45 billion of losses on the life and non-life side from COVID over the last two years, so that adds to the burden. You have low interest rates, and all the inflationary pressure that we are seeing at the moment, various different types of inflation are creating reserving risk.”
“So, it’s a pretty tough environment, but at the same time you have quite a lot of reinsurance buyers around the world who have done what they said they would do to their reinsurers, and haven’t delivered losses, so they will have been questioning why they have to be paying increases. And those are always going to be difficult conversations.”
Surveying the market, it would appear that renewals went largely as expected, by which is meant that rates continued to improve for most lines of business across both property and casualty areas of the industry, although there was significant variation between risk portfolios and territories.
According to Howden, the Global Property-Catastrophe Risk-Adjusted Rate-on-Line Index rose by 9% at 1 January 2022 – higher than the 6% recorded last year, and the biggest year-on-year increase since 2009, taking the index back to pricing levels last recorded in 2014. Given the higher weighting of European programmes up for renewal at 1 January, it noted that loss experience in the region was a key inflating factor.
On the casualty side, according to Howden, high levels of competition for profitable proportional business, combined with cedants’ willingness to retain more net exposure, pushed up ceding commissions across multiple accounts. As a result, London market casualty reinsurance rates-on-line, including adjustments for exposure changes and ceding commissions, rose by 5% on average.
“Not surprisingly, loss developments and rising rates were the main points of discussion at the January renewals,” says Catherine Thomas, senior director of analytics, AM Best.
The last several years have seen a relentless rise in the frequency of non-attritional losses, which has added a layer of volatility to results and supported the need to focus on price.
The positive pricing momentum—a trend that started in 2018—has been driven by rising loss cost inflation, natural catastrophe activity, and historically low investment returns.
Unfavourable loss cost trends and high cat activity continue to dampen returns on capital, which has kept the industry focused on the need to push for more rate increases.”
According to Thomas, the uncertain economic environment and rise in climate-related catastrophic events have led to enhanced market discipline, including tightening terms and conditions. This, coupled with substantial cumulative rate increases, has improved underwriting opportunities for almost all reinsurers, with the market seeing “a growing demand for reinsurance capacity as primary insurers seek capital efficiency and stable results—a trend that is benefitting even small reinsurers.
“2021 renewals were broadly in line with our expectations i.e., continued – albeit more moderate rate increases – driven by loss affected lines,” adds Helena Kingsley-Tomkins, vice-president and senior analyst at Moody’s.
“Price rises have been supported by recent elevated natural catastrophe activity, positive primary commercial insurance pricing dynamics as well as strong demand for (re) insurance thanks to the economic recovery.”
Indeed, she says she expects further price rises over the coming 12 months, given that 2021 has been another year of above average catastrophe losses and as reinsurers enhance their modelling and views around catastrophe risks, particularly in relation to secondary perils.
THE CATASTROPHE CONUNDRUM
The scale of the catastrophe losses going into this season’s renewals has been a massive contributory factor. As Mark Wheeler, CEO of specialty carrier Mosaic Insurance observes: “Cat losses are enormous now; it’s like water off a duck’s back! Last year is going to be an event of over $110 billion, and the format of those losses is not friendly from a reinsurance perspective. That’s the second time in five years that we have had a loss of over $100 billion, and I think what is really interesting within that is that it’s only the fourth time in history. We’ve almost become immune to it, and people bandy these numbers around, but they are big proportions of the industry capital base. Sure, there are earnings coming in offsetting that, so it’s not damaging to the capital base, but that is real.”
Such sentiments are echoed by Aon’s Van Slooten, who suggests that elevated nat cat activity is the biggest topic in the industry at the moment, and the extent to which it may or may not be related to climate change: “The absolute level of the loss is an issue, but it’s also about where the losses are coming from. Some of these events have been quite unusual, and they have generated losses which weren’t anticipated, coming from secondary perils that aren’t so well understood or so well modelled. The investors have been surprised and disappointed, and I think for some of them, a fifth year of major losses has really got them questioning what’s going on here and whether they want to continue participating.”
“The frequency and intensity of events do seem to be increasing, and there are some underlying issues in terms of changing exposure, with people moving to the coast and all sorts of things like that. There are definitely changes in concentrations of exposure that are a factor as well, but the overlay of climate change is very hard for people to predict how that is going to develop going forward. So the question people are asking themselves is: we had more than a decade between 2005 and 2017 where there was no major land-falling hurricane in the US, and lots of people made lots of money. We’ve now had five years of well above average losses in that period-about $575 billion. It’s an unprecedented burden on the market.”
“People are asking themselves: has the climate really changed that much in the last five years? Is this the new normal, or could we actually reset to what we saw only five or six years ago? And nobody knows; nobody can give you an answer to that question, and investors are having to come to a view on that.”
Continuing uncertainty over COVID-related claims has also been a significant factor in these renewals. As discussions were ongoing, the more infectious Omicron variant continued to spread rapidly, though thankfully appearing to produce less severe disease than the globally dominant Delta, according to World Health Organization.
“While there remain some outstanding issues with respect to COVID-19, predominantly business interruption claims and how they will be shared between primary insurers and reinsurers, we believe that visibility over ultimate P&C reinsurance COVID-19 losses has improved with the easing of lockdown restrictions and thanks to the economic recovery,” says Moody’s Kingsley-Tomkins, who adds that Total pandemic related losses, estimated at $37 billion as of June 2021, “are in our view akin to a very large catastrophe event. There are some specific areas where further new pandemic-induced losses could materialise (e.g., event cancellation, and business interruption on multiyear property policies, an uptick in D&O claims, and E&O), but these should remain manageable.”
She says that most reinsurers are also standing by their previously disclosed claims estimates, maintaining that their reserves against 2020 COVID-19 claims are sufficient. Nevertheless, there is some uncertainty and potential for prior year reserve increases related to the resolution of legal disputes in favour of claimants in business interruption cases, but any further increases in loss estimates should be manageable for the reinsurance sector. Looking at the largest European reinsurers (Munich Re, Swiss Re, Hannover Re and SCOR), the peer group recognized just €0.4 billion of COVID-19 related claims over the 9m of 2021, less than 6% of the €6.3 billion it has absorbed since the start of the pandemic in March 2020.
However, where there is greater uncertainty is on the life and health side, where COVID-19 is still weighing heavily on earnings in 2021, she notes: “The aforementioned peer group, for example, booked 54% of its total COVID-19 life reinsurance losses so far during the first nine months of 2021. Moreover, reported mortality claims increased by 18% in Q3, up from a quarterly increase of 12% in Q2, driven largely by the US. As a result, these group’s life reinsurance results remain subdued.”
According to Aon’s Van Slooten, the main factors relating to COVID as far as the 1.1 renewals have been uncertainty around reserving for business interruption and contingency losses, though this is not an issue which will have been resolved once and for all in recent weeks:
“I think there are a number of cedants that are trying to make recoveries from their reinsurers at this point, and there has been a lot of contract language gone through, with some quite difficult conversations, most of which I think will be deferred again. Some of those issues may end up getting resolved, in other cases, this may be an ongoing process for the next two to three years.”
What is clear is that no one, whether they be insurer or reinsurer, can really know how the current COVID situation will pan out this year, he adds: “Prior to this variant, there was a view that it was going to start to tail away, given the vaccination programme… a lot of the losses sadly relate to excess mortality, particularly in the US market where a lot of the exposure is, but also in places such as South Africa and India, for example. With the vaccination programmes, there was the expectation that those losses were going to begin to tail off, but I think there will be some impact, even from the last variant, for the next couple of quarters. There is an open question as to what the impact of the new variant might be, and whether that might continue to generate claims well into next year.”
Not unexpectedly, cyber has received keen attention as part of the 1.1 renewals, as rate increases began to accelerate in 2021 for insurers in response to ransomware loss trends as well as higher demand for cyber insurance, with double-digit rating increases across the board for coverage.
“Over the past two years, a deteriorating and increasingly complex loss environment has challenged the profitability of cyber insurers, with ransomware attacks the principal driver of losses,” says AM Best’s Thomas. “In response, insurers have increased loss picks and have materially increased rates. There has also been a tightening of terms of cover, and we’ve seen a much greater focus on risk selection and risk mitigation. The potential for catastrophic losses from this systemic line of business is also weighing on (re)insurers’ assessment of risk-adjusted rate adequacy.”
She adds that the uncertainty associated with potential aggregate events and a lack of a robust claims track record for this relatively young market mean that cyber insurers have tended to protect themselves with significant reinsurance, quota share treaties and stop loss cover typically utilised, as well clash cover working across multiple lines of business.
“But capacity in the reinsurance sector has continued to tighten, and we have seen reinsurers taking a much more cautious approach to this risk, with more capacity providers including loss ratio caps or event caps within the protections they offer,” Thomas notes.
“At this year’s renewals, in addition to tighter wordings and further rate increases, reinsurers have intensified their scrutiny of the risk-mitigation measures taken by insurers and their clients, as well as cedants’ data quality, as they seek to understand and control accumulations related to cyber risk.”
Given the scale of cat losses in 2021, there was an expectation going into these renewals that Insurance Linked Securities (ILS) capital would be slightly dented at 1.1s, and according to observers, this is, broadly speaking, what has panned out- though the broader picture for the alternative capital space has been more nuanced.
According to Thomas, third-party capital abounds but remains under pressure. Despite a number of investors reassessing their risk appetite and remaining issues regarding trapped capital, for example, AM Best and Guy Carpenter estimate total dedicated reinsurance capital at USD 534 billion as at the end of 2021. Out of this, $94 billion corresponds to ILS capital, reflecting an increase of more than 3.5% in respect of the previous year.
She notes that volatile returns between 2017 and the third quarter of 2021 prompted some providers to reassess the levels of their deployed capital, return measure expectations, and time until capital (collateral) is released: “Other providers doubled down. Five of the ten largest third-party capital capacity providers expanded their appetites for property catastrophe volume in 2020; the other five diminished the capital deployed. That said, third-party capital continues to provide retrocessional opportunities to rated reinsurance balance sheets, and the level of alternative capital remains substantial.”
“We had actually seen some encouraging signs, so I would say that in the year to the end of June, we had actually seen some modest growth in that area, so we had seen some investors committing new funds,” comments Van Slooten. “The one area that has been very active is the property cat bond market – all the data will tell you that 2021 will be the record year for property cat bond issuance. That’s the bright spot, and the reason for that is that with a lot of those structures, there is a defined trigger, so it will be based on a defined peril and potentially a defined level of industry loss.”
From an investor’s standpoint, he adds, it’s much easier to establish whether or not you are going to face a loss in any given scenario, whereas in a lot of other areas, such as collateralised reinsurance, for example, sometimes it takes a long time for a cedant to establish whether they are actually going to incur a loss, and in the interim period they won’t release the collateral: “That makes it much less efficient for the investors. If they can’t keep rolling the same collateral and end up being committed for a multi-year period, which was never the intention, it undermines the economics for investors.”
RULES OF THE GAME
Given such a fascinating and complex, renewal season, one thing is now clear, according to Mosaic’s Wheeler: the rulebook has changed. “This isn’t about capital – the industry is better capitalised than at any other point in my career,” he says. “This patently isn’t reinsurance led, although that is becoming a factor for the next stage of price development; reinsurance cost has gone up, and margin is flimsy because of this hole we have to dig ourselves out from. If you take Lloyd’s of London as a proxy, they are talking about a combined ratio of 95% for this year, which is good historically, but is it enough?”
And there remains one rather nasty elephant in the renewals room which could yet prove to be a more significant challenge than those already identified in this report: inflation. As Howden notes in its analysis, taken in the round, long-tail classes of business were last year largely insulated from acute inflationary pressures and continued to benefit from depressed loss frequency, even if investment yields remained near historically low levels. However, the broker observes that the outlook from here will be closely tied to macroeconomic developments, and inflation in particular, while the prospect of carriers replicating investment returns achieved during periods of high inflation looks remote.
Given such a challenging environment, as a recent McKinsey report makes clear, to thrive over the coming decade, insurers need to secure the tech capabilities they need in order to secure an advantage in terms of agility, growth, and cost ratios, and to ensure they are better able to match the increased need for digital offerings. Yes, it would appear that for this most recent series of renewals, the extraordinary upwards pricing momentum which has characterised the P&C market in recent years appears to have been broadly sustained. But there can be little doubt that pricing across several segments will come under considerable pressure next time around. For those carriers who have not adapted to the changing digital landscape, with a consequent impact on operating costs, the 2023 1.1 renewals will be an even more testing series of negotiations.