Higher retentions on property-catastrophe reinsurance programs are here to stay going into next year’s renewals, reinsurance brokers predicted recently.
But whether it would be possible to cede some more of the losses they are experiencing from secondary perils like severe convective storms with their retentions wasn’t the only question on the minds of cedents.
During virtual briefings hosted by Guy Carpenter and Aon in the run-up to the Rendez-Vous de Septembre in Monte Carlo, broker executives faced a more direct question: How long will the hard market last?
It was the second question posed to Guy Carpenter executives and the first posed during the Aon briefing, after executives delivered opening remarks about more orderly renewals, reinsurer profits, record catastrophe bond volumes and storm losses.
“It’s a function of supply and demand,” responded David Priebe, Guy Carpenter’s chairman. “We are starting to see some capital come in, but not nearly at the quantum that I think will dilute the current situation,” he said.
Still, Priebe noted that reinsurers’ financial results are back in the black, “and quite frankly as we’ve been talking to investors throughout the world, there’s continued strong interest in investing in insurance risk. And so we expect that capital will be coming in, but that capital is really expecting continued discipline, transparency around risk—the ability to measure risk and the ability to truly quantify and understand their return potentials,” he said.
“We are starting to see some capital come in, but not nearly at the quantum that I think will dilute the current situation.”
David Priebe, Guy Carpenter
Andy Marcell, chief executive officer of Reinsurance Solutions at Aon, said the duration of the hard market “particularly depends on where you are,” alluding to the softening of higher layers.
“Excess of a 15-, 20-year return period, there’s quite a lot of competition for that. And the higher up the stack you go, the greater the competition, right?” he said. “There’s ample capacity and appetite” there, he said. “When you get lower down—I don’t think that below 10-year return periods, there’s a significant shift in appetite,” he said, offering the exception of individual “private deals” that might be possible for specific cedents.
Responding to a related question about whether reinsurers will abandon their newfound pricing and structural discipline at 1/1, Marcell said that with challenges like inflation and currency exchange still in play, “I don’t expect there to be a huge expansion of capacity. But by the same token, the discipline that the reinsurers arrived at is that they want to provide covers for severe cat. They’re comfortable, in our opinion, providing that cover for severe cat. And so that’s a discipline that will exist.”
“There will be occasions where for certain types of customers, or [for] a special relationship, or [in] trying to help some regional carriers, they will drop down and do some private deals around earnings. But I think the overall discipline that they have will sustain,” he concluded.
Executives of both brokerages reviewed developments in the catastrophe bond market as well, pointing to record levels of cat bond activity through the first half of the year—over $9 billion of limit placed through 41 different bonds for 37 unique cedents, including seven new sponsors, according to Guy Carpenter. They also addressed questions about how long the positive momentum in the cat bond market would last and about investor appetite for catastrophe risk.
Lara Mowery, global head of distribution at Guy Carpenter, said the cat bond product continued to have “significant appeal for investors” because it is well-structured in terms of exactly “what it’s covering and how it’s covering” risk. Cat bonds have “certainty features” like defined perils and a defined time frame, she explained.
Insurance buyers pivoted to cat bonds throughout 2023, she said. “One of the things that we did see is relatively flat demand from a traditional treaty capacity standpoint as buyers evaluated the tradeoffs between the price and the coverage that they were able to achieve,” she said, noting that cat bonds filled in the gaps of cedents’ traditional programs. “Investors in that space are responding in kind, [creating] very, very healthy deal flow happening in that space.”
At Aon, Mike Van Slooten, head of Business Intelligence, Reinsurance Solutions, said he believes the catastrophe bond market “is likely to provide some competitive tension in certain markets around the world as we head into the renewals.”
Reinsurance Capital Rebounds; Most Invisible
Guy Carpenter and AM Best jointly project that total dedicated reinsurance industry capital for 2023 will be $560 billion—$461 billion of which relates to the traditional industry (with the other $99 billion from third-party capital). Traditional capital had shrunk to $411 billion at year-end 2022 from $475 billion in 2021—mainly as a result of rising interest rates reducing values of fixed income holdings—but the projection puts traditional capital back near the 2021 total, Mowery reported earlier in the session.
“Just as important to rebounding capital levels is the motivation to deploy capital,” she said, going on to review projected profit figures.
Returns-on-equity for the reinsurance sector are now materially above the cost of equity—18.3 percent vs. 11.4 percent for 2023 by Guy Carpenter’s estimates. And Guy Carpenter is forecasting double-digit ROEs for 2024 and 2025 as well (17.0 percent and 13.5 percent, respectively).
Projected returns could add another $50 billion to total equity by 2025, Mowery said.
Both Guy Carpenter and Aon noted that new reinsurance capital raised in 2023—$4 billion by Guy Carpenter’s estimate—hasn’t been put into highly visible new startups. Instead, it is being raised by existing reinsurers like Everest and RenaissanceRe.
Van Slooten said Aon estimates $10 billion of incremental capital came into the industry, with half of that going into cat bonds. Kelly Superczynski, head of Capital Advisory, Reinsurance Solutions, explained the lack of investor interest in putting capital into new startups.
“There’s the perception that investors can’t exit at much beyond book value after five years,” said Superczynski, noting the general exit time horizon for new startup investors and investor worries about the frequency of secondary perils denting returns.
“The reinsurance sector is currently trading at a median price to tangible book value of 1.34 times, which is up from [1.17 at] the end of Q2,” she said, noting that such multiples aren’t figures that investors get super excited about.
“The discipline that the reinsurers arrived at is that they want to provide covers for severe cat. They’re comfortable, in our opinion, providing that cover.”
Andy Marcell, Aon
Aon estimates a first-half ROE of 17.5 percent, up from a minus 1 percent return on average equity in 2022, and similar projected ROEs for 2024. Those are “closer to what investors want, but they want this over the cycle, not just at the peak of the cycle,” Superczynski said.
Still, she said, while investors aren’t motivated to make balance sheet investments in the reinsurance sector, they “do recognize that cat risk today is a good strategy, which is why they’re investing in sidecars and they are investing in ILS to take advantage of current pricing.”
She asserted, however, that the “fastest-growing pool of new capital is supporting the legacy reinsurance market. “Legacy is a bit of a misnomer,” she added. “A lot of these [loss] reserve transfer deals include live reserves or continuing books of business, and also the deals now include retention of claims control,” she said.
“We think the industry’s grown from about $5 billion to $25 billion of capital just in the last six years. And we know that there’s more capital waiting in the sidelines to come in as deals come to market,” she said, noting that high interest rates make these interesting for buyers and sellers.
Superczynski reported that Aon is also seeing traditional reinsurers allocate capital to structured solutions. “We’ve worked to develop what we call an ‘enhanced quota share’ that trades casualty for some property-cat risk,” she said, without providing further details.
Casualty Appetites and Ceding Commissions
Broker representatives also addressed questions about casualty reinsurance appetites and levels of ceding commissions expected for casualty reinsurance business.
Dorothée Mélis-Moutafis, North American brokering executive at Guy Carpenter, said that capacity for treaties providing coverage for the long-tail lines of business “remains adequate and not overly constrained.”
“Original market corrections that have taken place over the past few years have contributed to a sector that is robust and well-positioned to weather the challenges of today,” she said, noting, however, that renewal outcomes do vary depending on individual program dynamics.
“The impact of underwriting actions over the past three years, most notably the cumulative rate increases achieved and moderation of limits deployed, is proving positive in terms of underlying and treaty results,” Mélis-Moutafis said.
“As we approach 2024, we expect casualty capacity to remain stable,” even though insurers and reinsurers alike have concerns regarding the macroeconomic environment and the impact of social inflation. “How cedents address these factors remains a key consideration and influence on treaty terms and the successful execution of such placements,” she said.
Bottom line: “Reinsurers have a healthy appetite for the diversification of these longer-tail lines as they hold or shift away from certain cat segments or geographies,” she said.
Addressing the specific question of whether there will be pressure on ceding commissions going forward, Mélis-Moutafis said the market is disciplined and “there is pressure for good returns,” which Guy Carpenter expects to translate into some pressure. “However, there is also appetite for the casualty—for the long-tail risk. So, it’s really dependent on the individual treaties, on the underlying rates on the portfolios, on the limits management of the clients and also on past-year development,” she said.
Marcell said there’s much more pressure for standalone D&O where rates are falling. Like Mélis-Moutafis, he stressed the rate discipline and limits utilization of casualty insurance clients describing them as “superb” and “remarkable.”
“It’s important for the reinsurance brokers, as we sit in the middle of these relationships, to be able to articulate to the reinsurers range of loss ratio outcomes that are possible—because the rate discipline, the limit utilization has been so terrific that the volatility around the loss ratio has inevitably shrunk to a degree.”
On the other hand, he conceded that reinsurers that have also written a lot of casualty risk over the years are seeing deterioration in their reserves. “Their big question is what are you seeing and how is that adequate in terms of the rate changes that are occurring today? Is that enough?”
“That’s the debate.”
Vowing to start early, offer transparency, and to use “the full weight of Aon’s analytics and hundreds of actuaries and [its] modeling capability” to get to a “mutual understanding” on ceding commissions, he concluded, “I think there will be downward pressure again. Largely, I think that they will hold at similar levels as 2023. That’s my prognostication.”
Priebe re-emphasized client-by-client distinctions. “The work that our clients have done on their underlying portfolios in terms of better balance, in terms of limit management—they’ve been driving price improvements for the last two-and-a-half, three years [means that] if you look at the expected returns, they’re pretty positive.”
“So, it’s not all around the ceding commission. It is really what’s the margin within that. And quite frankly, I think there’s a lot of ground to say that there shouldn’t be any adjustment downward in those commissions as we look forward,” Priebe said.