Many reinsurance executives have been left scratching their heads in surprise after last year’s natural catastrophes, which cost a whopping $100 billion but ended up having very little impact on rates. The insurance and reinsurance market isn’t behaving as it once did, when widespread rate increases followed major catastrophe events. Observers have started to suggest that the reinsurance cycle is dead.
After the hurricane losses of last year, reinsurers were expecting very sharp rate increases, “but almost nothing happened,” affirmed Denis Kessler, CEO of SCOR. “There were some rate increases, but it was extremely subdued, extremely limited to certain geographies, but so far from what we expected.”
Kessler spoke during a panel discussion at the reinsurance Rendez-Vous de Septembre (RVS), along with Dan Glaser, president and chief executive officer, Marsh & McLennan Cos.; Christian Mumenthaler, CEO of Swiss Re; Emmanuel Clarke, CEO of PartnerRe; and Dominic Christian, CEO of Aon Benfield. The panel was moderated by Philippe Donnet, managing director and group CEO of the Generali Group.
“Last year, people who have been in the market a long time…were kind of surprised because $100 billion obviously is not what it used to be,” said Glaser. “What that number has to be in order to cause dramatic change in a rating environment, I couldn’t say, but we now know it’s more than $100 billion.”
He recalled over the years being able to say: “Tell me what the losses are this year and I’ll tell you what the rates are going to be next year.” Previously, high catastrophe losses reduced the supply of capital, which put an upward pressure on rates and a reduction in the quality of terms and conditions, he explained. “So that played out cyclically many times over the last 30 or 40 years.” However, in a world of super-abundant capital, the losses may have to be very high in order to restrict capital, he indicated.
Christian at Aon Benfield said he spent most of the past year—having been in the industry for 34 years— in a state of surprise, finding it much more difficult to judge the effects on the market after major hurricanes. “In former times, just as Dan [Glaser] was saying, there [would be] a textbook response to pricing for hurricanes which we could all give. That’s much more difficult now,” he said.
Christian expressed deep surprise “that less than a year ago, $100 billion of catastrophe losses can produce a market in which today I am discussing, as Dan would be, with reinsurers the fact that prices in our view may fall. We’ll see how this materializes.”
Of course, it will vary by accounts and lines of business, “but it is a surprising component of discussion a year after those losses.”
The End of the Reinsurance Cycle?
“I have been going to Monte Carlo for 34 years, and each year we wait for the ‘Return of the Jedi’—or the return of the cycle. It seems the Jedi is not coming back. And it seems the cycle is not coming back. Maybe there is no more cycle,” said Kessler.
Previously, there was an underwriting cycle with ups and downs in rates, with sticky prices and capital movements when it took time to raise capital and time to change a program, Kessler said, explaining that capital once had “viscosity.” (See emailed comments from SCOR, which further explains why the reinsurance cycle is no longer visible).
“Today, you can raise capital easily. You can create a fund in less than one hour. You can issue a cat bond in maybe two weeks, three weeks,” he said. “Today, you [don’t have] cycles, but you have a succession of spot equilibria where demand and supply move around and rebalance continuously,” similar to the currency market.
So the cycle has—in essence—disappeared, Kessler noted. “That’s the world in which we now live.”
Clarke at PartnerRe weighed in, saying: “I think we’re a little quick here in saying the cycle is dead and there are not going to be cycles anymore.” Every business “has cycles, and we’ll continue to see cycles. But where I agree with Denis [Kessler] is that the last real cycle turns have been Andrew and the World Trade Center,” said Clarke, noting that the common denominator was that they were sizable events and were completely unexpected and outside the models.
“No one here can say we’ll never, ever have sizable, unexpected events anymore. But these things happen once or twice in a career. We know they’ll happen again. We just don’t know when. These are the events that will move the global balance of reinsurance capital,” he said.
“Until you have such things—and no one here is hoping or wishing or just waiting to see these things—then you’re only going to have corrections,” Clarke added. “I think what we have today—because we have a lot more capital—these corrections will be more muted, and they will be more regional or by product lines.”
He pointed to the example of 2011, when events in Japan, Australia, New Zealand and Thailand each brought a local correction but didn’t cause a cycle turn.
“I believe in this market today there are a couple of classes that will see some corrections, but the big cycle turns will be rare and triggered by unexpected events,” Clarke continued.
Worldwide Cyber Collapse
Kessler commented that last year’s hurricanes—Harvey, Irma and Maria—were within the industry’s “probability distribution space,” which is why they have not led to price increases.
“We have improved our risk management tremendously. We know that in the space of probability there was a possibility of three hurricanes of this size. It was not out of the probability space,” he added.
Kessler noted there have been only two events over the last 40 years that were large and unexpected: Hurricane Andrew in 1992 and the World Trade Center terrorist attack in 2001.
The only event that could bring marketwide price increases similar to what happened after Andrew or the World Trade Center would be a worldwide cyber collapse, “because that’s unexpected, because we don’t know how to measure it and because…this is not in our probability distribution.”
Another such event would be a global pandemic, which would affect the life insurance space worldwide, he added. “But otherwise, we know there will be large cats. We know there will be large hurricanes. We know there are large quakes. Come on—that’s what we’re here for,” Kessler added. “Very well-run companies…have all the tools to manage those events, anticipate them, cover them, do retrocession. We issue cat bonds to cover the peak risks.”
As a result, he said, reinsurers “were wrong one year ago to wait for price increases. We do our job, which is to face such incredible events, but they are in our probability distribution.”
Abundant Third-Party Capital
All the panelists agreed that excess capital in the market, supplied by third-party capital investors who are backing insurance-linked securities and collateralized reinsurance, contributed to the muted response. Low interest rates are leading pension funds and other capital market investors to seek noncorrelated investments in the insurance and reinsurance industry.
Donnet said that increased capital and competition from alternative (or third-party) capital has changed the face of the industry. Catastrophe bonds and collateralized reinsurance now amount to approximately $90 billion compared to $10 billion in 2005.
“On the one hand, these so-called private markets provide primary insurers with the opportunity to reduce the counterparty risk deriving from reinsurance protection,” Donnet said. “On the other hand, the abundance of capital softens the reinsurance market’s cycles, reducing if not canceling the price trends.”
Indeed, Kessler said, after last year’s hurricanes, reinsurers expected that ILS investors would be “extremely shy and not reload the instruments because they were a little bit afraid of what they discovered.” To the contrary, there is more ILS today than a year ago, and they reinvested massively in those ILS funds, Kessler continued.
Supply and Demand
Mumenthaler at Swiss Re said the insurance and reinsurance market is responding to the normal forces of supply and demand of capital.
“Clearly demand hasn’t grown a lot in the last five years, because insurance companies have wanted to grow, they have struggled to grow,” he said. “One way of growing is ceding less, for example.”
And on the supply side, there is capital coming from traditional reinsurers, which have made good earnings over the last five years, along with alternative capacity from pension funds, which are under huge pressure to seek return when all assets are yielding less, he explained. This abundant alternative capital has found its way into the reinsurance space with ILS and collateralized reinsurance, which works with a fronting reinsurer to collateralize catastrophe reinsurance contracts, Mumenthaler added.
ILS, or catastrophe bond placements, are still relatively complex processes, he said, noting that the filing is complicated and there is a lot of cost attached to it. “When people wanted to get into it, there were just not enough cat bonds for people to be satisfied with it.”
As a result, third-party capital “has found other ways in, which, I think, interestingly enough is actually more like classical reinsurance [via collateralized reinsurance],” he said. “I’m not sure there is a huge distinction between what we do and what this capital does. That has grown much more and is much less visible [than cat bonds]. But this pool of capital is huge.”
This additional capital source is causing the industry short-term pain because demand is not increasing while supply is plentiful, which is acting to depress insurance and reinsurance prices, he affirmed.
However, from a societal point of view, it is probably not so bad to have this additional capital source because too few people are insured against cat risks, he said, pointing to the example of California where only 13-15 percent of the population is protected by earthquake insurance.
“So in theory, there should be much more demand,” Mumenthaler said, noting that at some stage reinsurance will not be able to fully cover the growing demand. “So it’s good to have this additional capital source.”
“When we talk about [third party capital], we focus a lot on how much supply there is, but we don’t necessarily focus on how much demand there is for that form of capital,” said Clarke at PartnerRe.
“I would love to do a survey among our clients—how many of our clients would actually love to have 100 percent of their reinsurance [cat] placements with ILS capital?” he added. “I don’t think we’ll find a lot. So it’s true, there is a lot of supply of capital waiting on the sidelines. But I think there’s still a lot of demand for the value proposition of traditional reinsurers.”
What Happened to the Cycle?
Representatives of SCOR expanded on CEO Kessler’s RVS remarks about the cycle, providing more detail in an email to Carrier Management about why the cycle is no longer visible:
Historically, the P/C reinsurance underwriting cycle has been made of a succession of times of excess capacity and lack of capacity resulting in alternatively softening and hardening reinsurance markets. The cycle was mainly explained by the delays in both the transmission of information and the implementation of underwriting and capital allocation decisions.
We now live in a different—less “viscous” or less sticky—world:
- Transition to a more continuous and “real-time” market.
- Greater stability of financial conditions with the QE monetary policies and the disappearance of interest rates cycles.
- Lower barriers to entry.
- Greater fungibility of capital.
The consequence is that we now have a succession of “spot” market equilibria but not a cycle.
This does not mean that the pattern of prices cannot have a cyclical visual aspect (i.e., the aspect of a “wave”), but from a purely conceptual/economic standpoint, it will be intrinsically different than what we had in the past. It is the succession of “spot” market equilibria which will (incidentally) give this shape.
But the latter will not be the result, as in the past, of delays in transmission of information and implementation of underwriting/capital allocation decisions, which today are somewhat instantaneous.
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