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Inside In Full: Time for a bonfire of PMLs?

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Topics: Claims & Losses ESG Property - North America Risk Modelling

Hurricane Ida lacks the shock-loss quality of Winter Storm Uri. It seems unlikely to spawn the 4x loss creep we saw from Typhoon Jebi...

Adam McNestrie

And it will not transform the way in which a peril is viewed in the way that the 2017 and 2018 California wildfires were.

But even though it looks a lot like the sort of loss the market expects and is set up to respond to, it remains the case that the sector will be dividing a $20bn-$25bn bill in Q3 from this event alone.

The loss is manageable and except in isolated instances will represent an earnings hit for a very well capitalized sector.

Insofar as there is a noteworthy aspect to the loss, it could be the extent to which man-made factors like the late Covid economy and the Louisiana litigation environment amplify the loss.

This is creating a fair amount of uncertainty around how expensive it will be to adjust claims and repair damage, layering indeterminacy over a still unclear loss picture.

But panning out from the close-up on Ida, there are some important things to say about catastrophe risk.

First, the market has a mounting problem around cat risk, with persistently and consistently weak underwriting results which cannot be wished away forever.

Cat losses have been heavy from 2017-20, with 2017 the worst year on record for major losses.



And this has continued into 2021. Swiss Re estimated H1 nat cat losses at $40bn, 20% above the 10-year average of $33bn.

Creep around the recent European floods has taken the German component of the loss to $8.3bn, pointing to potential for a loss of approaching $10bn.

The California wildfire toll is also starting to pick up, and it is hard to see how this will not ultimately result in at least a $2bn-$3bn event.

Add in Ida at $20bn-$25bn, and you are at best just below an average cat year of $73bn – and potentially already pushing towards $80bn with four months remaining.



Indeed, the situation may be somewhat worse than that, with likelihood that other smaller "under-the-radar" cats mean the figure is already higher than this.

At the start of September, the majority of Atlantic hurricane risk remains, with September and October both highly active months historically and forecasts remaining in place for an above-average season.



The industry also still has to get through the rest of the US wildfire season and the Japanese wind season, while it is earthquake season all the time.

In and of itself, Ida may not be the event to really put the squeeze on underwriters, but it sets them up for real pain if it is the first of a sequence of losses – and 2021 becomes another year of initials like 2005's KRW and 2017's HIM.

These weak results also need to be seen in the context of the mounting evidence that the cat market has an issue with "latent risk", as has been evident with a sequence of unmodelled or poorly understood losses that have surprised the market.

Second, the longer this run of "bad luck" continues the more likely it is that boardroom pressure will build on management teams to revisit their models and downsize cat risk.

Albert Einstein famously said that the definition of insanity is doing the same thing over and over again and expecting different results.

Right now, this dictum might apply to the cat market which is placing its bets on the assumption that eventually there will be a zero-loss year, or that at least losses will revert to the mean.

The contrary argument is that people are too heavily swayed by recency bias and that cat modelling should be thought about in terms of 10,000-year data sets, but these modelled data sets are also not believed to account properly for the impact of climate change.

Increasingly, smart players in the cat market seem committed to the idea that there is a genuine ratcheting up of expected cat losses – the cat market's equivalent of social inflation – resulting from the effects of climate change.

Evidence is growing that climate change is responsible for increased severity, as well as driving greater losses from secondary perils like wildfires. And some in the industry maintain that it is also a cause of increased frequency of loss.

I would also stress that there is an uncomfortable intersection right now between the sustained negative impact of cat exposures on results and the fast-accelerating ESG Awakening.



As boards and management teams try to align company strategy to ESG objectives, a big bet on the mean reversion of cats may seem to run counter to efforts to build businesses that are climate-resilient.

And while it may be too much to say that underwriting a big cat book is anti-ESG, it is possible to see boards influenced by the zeitgeist arguing that management teams looking to press ahead with the same old underwriting strategy are on the wrong side of a structural change.

I acknowledge that some may choose to make the contrary argument – that is to say that extending catastrophe protection to communities threatened by climate change fulfils the social mission of the industry.

Third, it is at least possible under these circumstances that you will see a “bonfire of PMLs” from some of the smarter companies, with what could be early signs of downsizing exposures already evident in some quarters.

PMLs for cat treaty writers like the Bermudians have already come in heavily over the past 15 years, with a massive step down after the impairments resulting from Hurricane Katrina.

This was intensified through the soft market of 2013-17, aided by the availability of third-party capital and cheap ILS-backed retro.

The data is incredibly patchy, uneven and self-graded, with fewer and fewer public Bermudians to review in any case. But where there might have been an expectation that these companies would substantially re-risk their balance sheets given the 2018-20 travails of the ILS market and the firming of the reinsurance market, this is not necessarily evident.

Arch provides an interesting case study. While there have been signs of a pick-up of PMLs from a nadir of 4.0% of equity for a 1-in-250-year in 2019, with its property cat reinsurance book doubling in 2020 – Q2 showed the company throwing this into reverse. Last quarter the business cut its Q2 cat reinsurance book by 26% despite further rate rises – pointing to an even larger reduction in gross exposures, and at least raising the prospect it is responding to an evolving view of risk.

And although Fidelis does not disclose its writings or PMLs as a private company, in an interview in March 2021 with this publication, CEO Richard Brindle told this publication that its cat PMLs are the lowest they have been in his career, with the company not growing its cat portfolio in line with its increased capital base.

This could represent the over-interpretation of a couple of data points, but given the degree of volatility in these books it would be easy to see why Bermudians/specialty players with access to increasingly diversified sources of premium would choose to dilute their cat bets.

Pre-ILS excess cat returns used to drive the whole Bermudian business model. A structural reduction in the available returns owing to ILS first challenged this reliance on cat treaty from 2013 onwards. It may be that climate change – the cat market's social inflation – deals it a second heavy blow.

Or, as a function of this, it may be that cat pricing has to fundamentally re-rate to draw in the required capacity to support the risk.


Inside P&C provides unparalleled market intelligence on the entire US P&C market – from small commercial and personal lines right through to reinsurance and Bermuda. Redeem your complimentary 14-day trial for more premium content from Inside P&C.

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