Risk appetites recalibrated
Major losses and growing exposure to secondary perils have stimulated an increase in demand for reinsurance among insurers ahead of renewals, according to Mike Van Slooten, Head of Business Intelligence for Aon’s Reinsurance Solutions business.
In the run-up to renewals, what are the main drivers of market conditions?
Pressure was mounting on the reinsurance market even as we entered 2020. Reserve adequacy was a growing concern, interest rates were falling and trapped collateral was impacting the retro market. COVID-19 has exacerbated all of these pre-existing factors, as well as undermining earnings for 2020. Put all of this together and we’re likely to see pricing pressure on a broad front come 1 January. However, it remains to be seen to what extent this will translate into actual rate increases.
Is the depressed investment environment influencing pricing?
It is focussing minds. Interest rates are now at close to 0% in all major markets and are likely to remain there for some time. The whole industry needs to come to terms with what that means for business models Typically underwriting returns will need to increase to compensate for lower investment returns if companies are to have any chance of covering their cost of capital.
The recent Aon Reinsurance Aggregate report analysed reinsurer results for the first half of 2020. What are your biggest takeaways?
We wanted to understand how COVID-19 had impacted results in the first half. Both sides of the balance sheet have been hit, with volatility in the capital markets impacting asset prices and pandemic-related claims coming through on the liability side. As a result, the reinsurers we track reported an overall loss for the period of $1.1bn, on top of a poor run of results since 2017.
The positive aspect was the continued resilience of the sector’s capital base. Several companies have demonstrated their continued access to capital by raising new equity and/or debt in the second and third quarters. Losses and exposure growth mean the sector isn’t as well capitalised as it was five years ago, but it is still well capitalised.
What does the demand side of the renewal equation look like?
We’ve seen an increase in demand for reinsurance since 2017, partly due to the recalibration of risk appetites in the wake of major losses and growing exposure to secondary perils. This trend has continued into 2020, as substantial losses and uncertainty have been generated from an unexpected source (COVID-19) and natural catastrophe activity has been far from benign. Reinsurance is again proving itself to be a very flexible and valuable tool in the management of earnings volatility.
What are the prospects for the ILS market and investor appetite?
It depends on the product type in question. Cat bonds and ILWs are usually tied to specific natural perils and tend to require a significant loss before they come into play. The impact of recent events, including COVID-19, therefore hasn’t been that significant. That greater certainty, plus the liquidity of the cat bond product, has resulted in continued investor appetite.
The situation is different when it comes to reinsurance sidecars and collateralised reinsurance deals. Here there have been more losses and significant volumes of collateral have become trapped. Most investors in these products won’t have been expecting to take losses from a pandemic and some may now be dragged into coverage disputes. That uncertainty adds to pre-existing concerns around climate change, loss creep and model credibility.
Significant efforts are now being made to address the issue of trapped collateral and that, together with the prospect of higher pricing, may be sufficient to start drawing investors back into the sector.
Is the current challenging environment conducive to consolidation among primary and reinsurance companies?
That pressure has been there for a while. The world is becoming an increasingly complicated place and exposures are increasing all the time. Not everyone has an underwriting franchise that can make up for the deficiencies on the investment side and, for risk carriers, the benefits of scale and diversification are only going to become more apparent over time.
