This has played out far more dramatically than expected, with incredibly decisive moves from a range of reinsurers. The slashing of aggregates by 25%-50% has not been unusual. And Axis, of course, is out of cat treaty entirely.
Bermuda – long known as the key center of cat underwriting – has been stampeding away from the business. And there are few contrarian voices. Growth markets can be counted on one or two hands for a line of business with dozens of participants.
Swiss Re, Munich Re and Hannover Re – with their monster balance sheets – have been willing to do more. The hardcore opportunists like Lancashire, Ariel and DE Shaw too are leaning in. But most reinsurers – battle-wearied by years of losses – want to pull back.
The shifting risk/reward matrix
In an environment with shrinking supply and growing demand driven by inflation of values in commercial property portfolios, the market clearing price for cat treaty inflected substantially upwards at July 1. Various US cedants were obliged to pay increases of 20% or more for their covers.
Mirroring the developments in the retro market from 2019 onwards, aggregate capacity and quota share are also becoming increasingly more difficult to buy.
It is clear now that pricing in the US commercial property market has crossed over, with reinsurance rises running in advance of those achievable in the primary market.
Perhaps even more importantly, retentions on occurrence covers rose substantially, and in some cases doubled. This reflected the combined effect of the reduced availability of capacity available at low-return periods, and the need for strictly limited agg to be shifted upwards to provide cover for extreme scenarios.
As higher pricing and higher retentions filter in for the rest of the US market through the major renewal dates to come, it will shift the risk/reward matrix in ways that could dramatically influence primary market behavior.
Two E&S insurers suggested that they modelled the need for an additional 12 points of rate to offset a 20%+ increase in XoL without squeezing margins. Old school reinsurance-driven rate rises now look likely, and the first signs of a reacceleration of rate rises are already in evidence, potentially pointing to a “micro-cycle” in cat-exposed property insurance.
The increased pricing leaves insurers with the prospect of ceding away more margin to reinsurers, while the retention hikes and reduced availability of agg cover leaves them facing the prospect of carrying more volatility.
After years of elevated frequency of small cats, there is still a lack of confidence that insurers are being paid adequately for the volatility
Given that they also likely need to buy more limit at the top end of their programs to protect their capital against tail events, insurers are left facing challenging trade-offs.
After years of compound rate rises on cat-exposed property now is theoretically a good moment to take more net at the bottom of a program, walking the attachment point which may have crept as low as one-in-four or one-in-five, back up to one-in-eight or one-in-10.
But after years of elevated frequency of small cats, there is still a lack of confidence that insurers are being paid adequately for the volatility. And even if insurers are confident the margin is there, investor dislike of earnings volatility remains intense.
Insurers will not behave uniformly under these circumstances. Particularly smaller, reinsurance-dependent firms will likely look to scale back the amount of cat aggregate that they deploy to control volatility.
Others may seek to pay up in an effort to hold their attachment points steady, with others privileging securing additional protection at the one-in-100 or one-in-150 level to take account of the inflation of values in their portfolios.
All will likely push harder on price as they work to ensure they are properly compensated for the risk they are keeping net.
Insurers may like to maintain that they operate like net underwriters. But if you are able to put a collar around cat risk with interlocking occurrence and agg programs, effectively locking in a maximum cat loss, you will write differently on the front end if that ceases to be the case or if the number materially rises.
The growth opportunities outside cat
As commercial lines insurers weigh up taking on a larger share of the losses and volatility from attritional cat activity, they do so (like reinsurers) in a marketplace that offers multiple opportunities for the deployment of capital that clears return hurdles.
Bermuda’s decision to oversee a Bonfire of Cat Limits has been enabled by its conviction that the casualty, professional lines and specialty business would be able to deliver the top- and bottom-line needed to allow it to be dropped.
Commercial lines insurers also have opportunities to deploy their capital into a range of other lines where rate adequacy is strong, or where rate rises still exceed loss costs – something which would make the decision to throttle down on cat property easier right now.
Hard choices are coming for insurers that want to deliver profitable, low volatility results
Right now, however, the dilemma is just coming into view. And it is not even clear yet how acute the trade-offs will become.
Much depends on the remainder of season, and the rest of the cat activity through the balance of the year after an H1 which is 11% ahead of the 10-year average.
But we do know that hard choices are coming for insurers that want to deliver profitable, low volatility results, while providing full-service solutions to brokers and clients.
Since the ILS market started to pull back from subsidizing stupidity through retro, and AIG and FM Global pulled back on their large-limit strategies, the cat market has been endeavoring to resolve where risk should sit in the value chain and how much should be charged for it. It is yet to satisfactorily answer either question.
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