as senior executives from both firms made the case – albeit with different reasoning – that the industry is currently underpricing cat risk.
With Zeta striking Louisiana as the 11th named storm and sixth hurricane to make landfall on the US mainland in the year to date, and wildfires still burning in the western states, the market needs no reminder of the frequency of cat losses this year.
RenRe president and CEO Kevin O’Donnell had already been vocal around recent renewals that the view of risk has changed for perils in certain geographies based on several factors including climate change.
But his targeting of underwriters or ILS managers who rely on a single vendor model – an approach he says doesn’t capture the true impact of climate change – and assertion that cedants will turn away from collateralised capacity to the security of rated balance sheets will have caught the attention of many in the sector.
As a widely recognised leader in the property cat arena, RenRe has for a long time sought to differentiate itself as an innovator of proprietary modelling that leverages its long track record in the sector and in-house resources that include scientists, meteorologists and engineers.
History not repeating itself
O’Donnell is clear in his belief that vendor models relying on the long-term historical record to estimate risk are missing a key element.
“Unfortunately, due to climate change, this long-term record of past experience may no longer be a reliable guide for what we can expect in the future. Making the problem worse, human behaviour can interact in complex ways with climate change to amplify risk of loss,” he said.
As well as incorporating historical data, cat models must be calibrated to the best understanding of how climate has changed and will continue to change, in order to categorise the full distribution of outcomes against which reinsurers can underwrite risk, the executive argued.
And he said anyone taking the single vendor model approach is open to an “optimistic representation of risk and overestimation of expected profit and dollar returns”.
The comments may well be seized upon by investors in ILS funds who have already been losing confidence in the asset class after several years of heavy losses and trapped capital issues in the collateralised space.
On the face of it, the remarks could be seen as a marketing ploy in what RenRe has previously described as a flight to quality among ILS investors. O’Donnell stated that the company’s own ILS partners rely on it to accurately model and price risk.
Shot across the bows
The comments could also be viewed as a shot across the bows of competitors that they had better toe the line and not behave irresponsibly in a market where there is a real opportunity to secure rate increases and prolong hardening conditions through 2021 and beyond.
RenRe has previously walked the walk, significantly trimming back its book in perils or geographies where it believes risk-reward has tipped out of balance.
This time though the company is approaching 1 January with an additional $1bn+ on its own balance sheet that it believes it can deploy profitably, so the stakes are high – as is the importance of messaging to the market.
And as a significant third-party capital manager, the Bermudian has also said it believes demand for collateralised capacity will diminish as cedants favour rated balance sheets, and now expects its Upsilon vehicle – which writes collateralised cover – may shrink.
Ignore history at your peril
If RenRe’s approach to assessing cat risk is based on the belief that historical patterns are changing, Swiss Re’s head of property underwriting for the US and Canada Mohit Pande told The Insurer this week that the industry is ignoring an important history lesson, at least in the context of hurricane risk.
In a video interview he said many underwriters and some of the more popular cat models have not been taking full account of the Atlantic Multidecadal Oscillation (AMO), despite no sign of a change from the warm phase of the cycle that tends to drive increased activity.
The executive suggested it was “truly inexplicable” that many industry players have switched back to a longer-term frequency perspective for hurricanes.
The AMO is characterised by fluctuations in ocean temperature and changes phase around every 25-40 years, and it is widely recognised that the warm phase of the cycle began in the mid-90s.
When sea surface temperatures are warmer than normal there tends to be more hurricane activity than the longer-term average, while lower-than-normal sea surface temperatures typically see less hurricanes than the longer-term average.
If the view is widely held at Swiss Re that the industry is truly underestimating hurricane risk – and consequently underpricing it – that is meaningful.
As the world’s largest reinsurer, the company has significant pricing power that can add real momentum, at least to property cat reinsurance renewals.
And if both executives are right – that cat models are failing to reflect established trends as well as the emerging patterns of climate change – then a radical shift in behaviour is needed for underwriters to correctly assess and price catastrophe risk in a world of frequency of severity.
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