Author: Ben Brookes
Rather than waiting for the next elusive hard market, successful (re)insurers are focusing on making informed underwriting decisions and taking well-calculated risks, according to Ben Brookes, managing director – capital and resilience solutions, RMS. A popular topic of conversation at the big industry gatherings is when the next “big one” will occur. What size and nature of loss could reverse the softening trend and see a return to hard market pricing? The influx of alternative capital into the reinsurance market over the past decade has transformed the traditional reinsurance cycle with no guarantee a market peak will follow the current trough. Insured catastrophe losses over the past few years have been significantly below average, particularly in comparison to major loss years such as 2005 and 2011. The majority of large-scale events during this time have resulted in a relatively low level of insurance claims due to the fact they have occurred in areas where insurance penetration is low. “THERE IS SIGNIFICANT DOUBT OVER WHETHER A U.S. HURRICANE LANDFALLING ON ITS OWN COULD TURN THE MARKET – PARTICULARLY BECAUSE U.S. HURRICANE IS ONE OF THE BEST-UNDERSTOOD AND WELL-MODELED PERILS, MAKING THIS A SCENARIO THE MARKET CAN MANAGE.” Recent frequency of North Atlantic hurricanes, typically a significant driver of insurance industry catastrophe losses, has been below average, with 2015’s record El Niño one factor behind the low number of tropical cyclones. These conditions have resulted in a protracted soft market, in addition to excess capacity and heightened competition within the reinsurance sector. There is significant doubt over whether a U.S. hurricane on its own could turn the market – particularly because U.S. hurricane is one of the best-understood and well-modeled perils, making this a scenario the market can manage. What we do know is that market-changing events are often surprise losses, revealing unknown accumulations lurking in reinsurance portfolios. Historical examples included Hurricane Katrina’s ability to overcome the defenses in New Orleans and the 9/11 terrorist attacks on the New York World Trade Center. A surprise event is the one you don’t see coming and is the one most likely to change the market. Given the quickly evolving nature of emerging risks such as cyber and pandemic, in addition to more traditional perils, such a loss could arise from numerous sources. Increasing insurance penetration in emerging markets has increased the assets-at-risk of natural catastrophes and the potential for major losses from regions that have been traditionally regarded as “non-peak.” “IT THEREFORE APPEARS INCREASINGLY UNLIKELY THE INDUSTRY WILL AGAIN SEE A MARKET ADJUSTMENT ON THE SCALE THAT WAS LAST WITNESSED IN 2001 AND 2005 DUE TO THE INDUSTRY’S FUNDAMENTALLY ALTERED CAPITAL STRUCTURE.” Given the way in which the industry has changed and the ability of capital to move quickly into the industry post-event, even a major shock or series of shocks may not have the same impact on the reinsurance cycle that it did in the past. Insurance-linked securities (ILS) fund managers continue to line up capital ready to be deployed the minute there is any indication of price hardening. It therefore appears increasingly unlikely the industry will again see a market adjustment on the scale that was last witnessed in 2001 and 2005 due to the industry’s fundamentally altered capital structure. While this is a good thing in terms of the structural integrity of the market, it also means reinsurance companies are faced with the prospect that current soft market conditions will continue to prevail and are, in essence, the new normal. In such an environment, risk selection and risk-adequate pricing are all-important, and there is very little margin for error. Competition in the reinsurance space is now a race to broaden insurance coverage, searching for new business in new territories and risk classes, rather than a race to the bottom with reinsurers competing on price alone. Modeling, data and analytics offer a competitive advantage to those reinsurers that use them to make informed decisions and take informed risks. Underwriters are scrutinizing model output more than ever before, overlaying their own assumptions and risk tolerance and looking for unexpected correlations between books of business to avoid being disproportionately impacted by any one event, and avoiding the private catastrophe. The ability to customize and blend multiple models allows users to tailor the models to their own view of risk, and complement and build on the insights from sophisticated exposure and accumulation management techniques, with increasingly real-time views of portfolio risk. Driving value out of these model output-based decisions will be the main differentiator as reinsurers navigate and make sense of the new reinsurance environment. For instance, one such opportunity is the ability to understand the “spatial correlation” of European flood risk in order to gain a diversification benefit and make quick and strategic M&A decisions by analyzing exposure data in real time. In a market coming to terms with this “new normal” of lower margins, but serving an increasingly important role in creating a safer society through broader coverage, the importance of effective catastrophe risk quantification and management has never been greater.