Chief among the negative drivers is heightened natural catastrophe activity that continues to test investors’ risk tolerance levels

AM Best has maintained its market segment outlook for the global reinsurance segment at stable, citing the presence of highly uncertain market conditions with positive and negative factors offsetting one another. 

Chief among the negative drivers is the heightened natural catastrophe activity that continues to test investors’ risk tolerance levels.

Negative pressures on reinsurers’ results over the last few years have been driven not only by traditional natural catastrophe events, but also by the growth of secondary perils, the pandemic, and, more recently, the Ukraine-Russia conflict, according to the rating agency.

Volatile risk landscape

This has been compounded by financial, economic, social, and geo-political uncertainty in general. Although the segment remains well capitalised, the instability of financial results and inability of most players to meet their cost of capital has tested investors’ risk tolerance.

This has been more evident in the ILS markets, including retro, which, owing to severe losses and trapped capital issues, has been unable to expand or re-load in recent years and continues to experience a significant flight to quality when allocating capital.

Anticipated rate increases started to attract new capital in 2019, based on the expectation that natural catastrophe activity would subside and return to average historical levels—which has been negated by the devastating Hurricane Ian, estimated to be one of the costliest insured events in recent history.

But even without major catastrophic events, the accumulation of small to medium-sized events has had a material impact on claims ratios, sometimes at unexpected times of the year (eg, Winter Storm Uri in Texas) or outside their usual geographical scope (eg, Hurricane Ida, affecting areas as far north as Canada).

Extremely unusual events (such as the Bernd system floods in Western Europe) are occurring, as wildfires and floods increase in frequency and severity worldwide.

Investors more cautious

The perception of volatility and uncertainty has been magnified for reinsurers, on the asset and liability side of the balance sheet as well as on the bottom line.

Investors may not feel as comfortable as they did before these issues emerged—and this is even truer for catastrophe risks, which were traditionally considered high severity, low frequency.

But when the frequency component rises beyond a certain tolerance threshold—which seems to be the case after five years of losses—investors will naturally reassess their positions and their return expectations.

Theoretically, at least, there should be a price high enough to compensate for that level of uncertainty, but few reinsurers feel that rate increases have reached that point yet, although the impact of Hurricane Ian is likely to accelerate pricing momentum at the January renewals. 

Retrenching from property cat

For the last two to three years, reinsurers have been shifting covers to higher layers of protection, raising deductibles, lowering limits, adding explicit exclusions, avoiding aggregate covers, restricting specific perils and geographies, and generally becoming more selective with their cedents to mitigate adverse selection and credit risk.

This has taken place at a time when cedants are craving more stable results and have put protecting their balance sheets at the top of their priority list.

Some companies have been actively shrinking their property cat exposures or even modifying their organisational structures and exiting altogether, although a few players—including some of the largest European reinsurers—seem to see the current environment as an opportunity to improve profit margins and consolidate their market positions even further.

Although the largest European reinsurance groups remain more cautious when it comes to risk selection, their longer-term views on catastrophe risks tend to be influenced by much greater risk diversification, size, and financial flexibility, supported by less of a reliance on the currently constrained retro markets or by better access to ILS capital.

Conditions in Florida—where problems stem from the low credit quality of cedents, concerns about widespread fraud, litigiousness, and a challenging regulatory environment—cannot be wholly attributed to the growing volatility of property catastrophe perils.