A hard market in short-tail lines — such as property and property catastrophe — across global geographies is likely to continue throughout 2023, after beginning the year with multi-decade-high pricing increases during the January reinsurance renewals, according to a report published by S&P Global Ratings.
The January 2023 renewals rival those of 2006 in the aftermath of 2005’s Hurricanes Katrina, Rita and Wilma, said S&P, quoting industry executives. However, unlike 2006 when increases were mostly in the U.S., January 2023 renewals price increases were global and broad, S&P explained.
At the same time, casualty reinsurance pricing remains firm after compounded price increases over the past few years, though rate increases have moderated in the U.S., said the report titled “Pricing Momentum Is Helping Reinsurers Turn the Corner.”
Such pricing momentum is necessary because reinsurers have failed to earn their cost of capital in the past five out of six years (2017-2022), which has led S&P to maintain a negative view of the global reinsurance sector. “Since 2017, the industry has earned its cost of capital in only one year (2019), and we believe the sector again fell short in 2022.”
The ratings agency cited a plethora of challenges that have hit the industry: higher-frequency and more severe natural catastrophes, mounting losses from secondary unmodeled perils (such as wildfires, floods and convective storms), loss creep, COVID-19-related losses, adverse loss trends in certain U.S. casualty lines, and historically low interest rates. In 2022 alone, the industry was hit by losses from the Russia-Ukraine conflict, persistent inflation, mark-to-market investment losses that eroded capitalization, and another above-average catastrophe year including the devastation of Hurricane Ian, S&P said.
“The question now is whether the pricing improvements are sustainable and whether they are enough to combat the endless headwinds the sector has faced that have muted performance for the past several years,” S&P said.
S&P was cautiously optimistic that “the tipping point is coming for a more stable sector view if reinsurers maintain discipline and demonstrate the ability to sustainably earn their cost of capital.” Evidence of such underwriting discipline was apparent during the January renewals.
January Renewals
Describing the price momentum in the renewals, S&P said a “hard market is here,” particularly in short-tail lines like property and property-catastrophe. “It’s not just significant rate increases that were in favor for reinsurers but also terms and conditions, coverages, and limits,” the report added.
“It seems that the global reinsurers have run out of patience after trying to catch up with the increasing [loss] cost trends over the past several years, resulting in multi-decade-high rate increases in property catastrophe during the January renewals,” S&P said.
“Along with pricing, reinsurers have tightened their underwriting standards and in some instances were willing to let go of business that didn’t fit their new view of risk. Reinsurers are wary of increased frequency of natural catastrophe losses and secondary perils. As a result, they have adjusted their coverages, notching up their attachment points and showing less or no intent to write lower layers, and tightening policy wordings for clear exclusions for certain risks such as cyber, war and terrorism,” the report went on to say.
By moving up the attachment points, reinsurers aim to limit their exposure to frequency losses and hedge against inflation, S&P continued. “Terms and conditions have tightened with clear wordings for specific risk coverage, and emphasis was given for named peril coverage,” it said.
In addition, reinsurers have shown less appetite for aggregate covers and instead have focused on per occurrence covers, S&P said, noting that reinsurers’ revised risk appetite indicates a distinct shift toward taking on severity exposure rather than frequency.
“The structural changes that took place during the January renewals will be long lasting because it will be hard for reinsurers to move back on their new attachment points.”
S&P predicted that significant price increases, along with these portfolio underwriting actions, will boost reinsurers’ underwriting performance in 2023. In addition, the high interest rates should boost investment income, offsetting the moderating rate increases in some of the U.S. long-tail casualty lines.
Alternative Capital
S&P said reinsurance capacity remains constrained on the property side partially as a result of reduced competitive pressure from the alternative capital market — particularly in the area of collateralized reinsurance and sidecars, which is dislocated after facing a string of catastrophe losses and resulting trapped capital — along with loss fatigue.
“Investors, especially in collateralized reinsurance and sidecars, have suffered significant losses over the past few years and are questioning the sponsors’ underwriting and modeling capabilities and becoming more stringent in their selection of who to partner with,” said S&P.
“As a result, some investors have reduced their exposure to these catastrophe risk vehicles or completely exited this market. Others have decided to switch to catastrophe bonds, which provide more transparency, liquidity and attractive returns.”
Casualty and Specialty Lines
Unlike property, casualty reinsurance capacity was plentiful, with reinsurers’ showing increased appetite for this segment, which meant the balance of power remained with cedents, S&P explained.
“Casualty lines saw more orderly renewals because reinsurers, like their cedents/primary insurers, have enjoyed compounded rate increases over the past few years, though rate increases have moderated in the U.S.”
On the other hand, specialty lines’ renewals saw dislocation in certain lines. “Large rate increases in aviation, political violence and terror were due to the Russia-Ukraine conflict fundamentally changing the view of risk for those lines of business. On the other hand, there is an influx of capacity in cyber reinsurance, which benefited from significant rate increases (30-50 percent) in 2022 with expected additional rate increases in 2023, though at a substantially slower pace (5-10 percent).”
Source: S&P Global Ratings