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Insider in Full: Grand designs Monte Carlo: Reinsurance renovation underway amid capital constraints

After two years of absence from the Monte Carlo Rendez-Vous, the reinsurance market is acutely conscious that it needs to go through the kind of spruce-up that the principality has been through in recent years...

Ostensibly capital levels in the industry are still relatively strong, and going by past market playbooks, this doesn’t fit the image of a market heading into a capital-constrained hard market.

Gallagher Re described the 11% fall in traditional capital in H1, due to mark-to-market investment losses, as a “red herring”.

But within the cat space in particular, the dynamic belies this surface image. Amongst all the public events this week, perhaps the headline that cut closest to the bone was from AM Best’s press conference, which baldly described the lack of capital market interest in the sector.

Five years of poor performance have created a capital-constrained market.

What headline capacity figures can’t easily capture is how much of the ~$95bn ILS capital is trapped or undeployable. Meanwhile, on the traditional market, subdued trading values ascribe little franchise value to reinsurance-heavy carriers and mean that reinsurers are aware that raising capital after any major cat loss would be problematically dilutive.

One question mark surrounds how much further cat de-risking reinsurers might pursue or whether the bulk of the pain from reductions from the likes of Axis, Axa XL, Everest Re, Fidelis and Tokio Marine Kiln has already been felt.

For others, there is little to no appetite to deploy any more capital, as managing their potential downside is top of mind.

There are some carriers that are seen as having the potential to “lean into” the hardening cat market, including the two biggest continentals Munich Re and Swiss Re, through to Bermudians such as RenRe, Arch, Hiscox and Ariel.

Meanwhile, there is chatter around new potential start-ups from the likes of John Doucette, although even if $1bn-$2bn of capital arrives into the market, it will at most provide a bit more optionality for cedants and brokers. Ageas Re also announced its entry into third-party reinsurance risk but plans a “limited perimeter” for 1 January deployment, as we covered here.

But the continuing refrain was that raising capital was an incredibly challenging prospect, and investor interest in balance sheet businesses is extremely limited. Notwithstanding the improving cat rates – the industry’s recent track record has investors wary of whether the industry can truly manage climate-driven risk and keep ahead of inflation.

The swathe of new demand on its way into the sector largely because of inflation – which as we noted could trigger a need among US carriers for a further $10bn-$20bn of cat limit for reinsurance for 2023 – will far outweigh any such incoming capital.

ILS prospects downbeat

On the prospects for ILS fundraising, there is an apparent split between some who are optimistic about the potential for ongoing cat bond growth and those still pessimistic on the fundamentals.

A frequently raised concern is that existing investors have been left with what looks like outsized ILS allocations, due to the major devaluations in their dominant equities portfolios, and this could lead to retrenchment to maintain target proportions.

Moreover, others suggest that rising risk-free rates of around 3% will make investors more averse to taking on more downside cat risk for the four additional points of yield above this risk-free rate. The four additional points is based on current gross cat bond yields of around 7%.

A factor offsetting this is that ILS spreads are still offering significant margin over similarly rated debt.

Even if the market swerves major storm losses this year and investors have profits to reinvest, it could take more than one good year to overcome some of the reticence around recent loss experience for newer investors who have entered since 2017.

All of this concern around capacity means that rate discussions have been on the backburner, with discovery around risk appetite the focus. But of course the level of rate increases will be crucial to influence how much “leaning in” occurs from cat reinsurers who seem willing to lift their exposure – and whether rate momentum shifts up to the point that it draws in any of those carriers like Everest Re or TransRe that could choose to deploy dry powder in the right circumstances.

But there seems less of a sense that negotiations at this year’s Monte Carlo represent any kind of gaming or rhetoric, or that reinsurers’ talk may prove as cheap as it has done in the past.

The reinsurers have “a bit more of a steely gaze”, as one put it.

Spotlight on T&Cs

In the absence of real chat around rate expectations, there has been a huge focus on achieving improvements to terms and conditions.

The changes that will be in the spotlight include: requiring payment for reinstatements, introducing sub-limits on secondary perils, hours clauses, and managing strikes, riots and civil commotion exposures.

With events like Covid in the rearview mirror and the Ukraine war still unfolding, the industry’s basic problem has been that it hasn’t known exactly what it was covering at some points.

Attachment points are also set for an overhaul as reinsurers continue to push their participation to more remote levels and walk away from attritional-level risk – where even if cover is available it could well be too expensive for insurers to cede.

Inflation, another major talking point of the event, also contributes to the sense of determination in the cat market as it sets a higher minimum threshold for achieving any real gain.

This is borne out by the fact that inflation has outpaced growth in the Guy Carpenter US rate-on-line index since Hurricane Katrina, as reinsurers lost ground in the soft market.  

Flight to quality

Winners and losers will also be created amongst cedants in a flight to quality. Single-class property writers with no other lines of business to leverage will likely have to pay a premium to market for their protection.

With capacity availability the key question for cedants, reinsurers that have long been taken for granted are now being courted early and assiduously by counterparties keen to secure some of their scarce cat aggregate.

There is perhaps more of a divide on whether the casualty reinsurance segment will over time become more influenced by inflationary trends. A few pointed out the risk to back-book reserves, but others believe it is still more than compensated for, in the same way that social inflation factors have been priced in at the primary insurance level.

However, there is a gathering consensus that cedes have peaked in Q2 after a historically unusual ramp-up in ceding commissions on liability lines from 2019-21 during a firming primary market.

Sources across the broking and underwriting divide pointed to the expectation of either flat renewals, or modest downward pressure of perhaps half a point to a point where cedes were in the high 30s, or potentially in D&O where primary rates are softening.

The transitioning casualty and professional lines reinsurance market conditions reflect combined concerns around loss cost trends, weakening primary market dynamics and increasing amounts of loss emergence in accident years 2013 to 2018 (particularly in D&O).

Alongside this, reinsurers with specialty books are looking to respond to the Ukraine loss by driving a combination of debundling of marine composite covers, and significant rate uplifts.

Meanwhile, as reinsurers work through the sprucing up required to win back the trust of the capital markets, they will also be conscious of needing to do so in the right way.

Amongst a focus on getting back to basics, the industry is also grappling with some newer challenges, such as achieving ESG goals while avoiding greenwashing, or increasing cyber capacity and managing accumulations in this niche.

Monte Carlo’s renovations appear to have taken one step forward – delivering new levels of shine to the Hotel de Paris and a far more pedestrian-friendly main square – but these developments sadly look like they will be offset by the coastal view destruction down by the Fairmont hotel.

As reinsurers focus on terms and conditions improvements that must steer them clear of yet more surprises – they need to ensure that breaking new ground must also be undertaken with the same constructive elegance.

 

Insurance Insider delivers global wholesale, specialty, and (re)insurance intelligence that enables you to act first. Redeem your complimentary 14-day trial for more premium content from Insurance Insider.

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