At a turning point

David Flandro, head of industry analysis and strategic advisory at Howden Tiger, examines the drivers behind transformation in the reinsurance sector.

Navigating a sea change: The evolving reinsurance landscape

Reinsurance is in its most transformative phase since the aftermath of Hurricane Katrina and the global financial crisis. A mixture of rising catastrophe losses, escalating interest rates, inflation and global conflict has accelerated the pace of change.

Five years ago at the Monte Carlo Rendez-Vous, experts speculated about the possible obsolescence of the reinsurance cycle. Such conjecture often signals the opportunity to make a bet on an impending cycle shift, and that is exactly what happened.

From prolonged soft market to volatile territory

Until 2017, the reinsurance sector experienced an extended soft market, marked by price declines, lower premium growth and a capital glut. The tide began to turn with a string of natural catastrophes, including Hurricane Irma in 2017. In the six years since, an ‘average’ insured catastrophe loss year has amounted to a staggering $111bn in real terms, almost double the previous six-year average. Secondary perils, especially wildfires, gained prominence as near-peak risks. Add a global pandemic, geopolitical conflict, claims inflation and asset-side impairment due to surging interest rates and, with hindsight, a 17 percent decline in dedicated reinsurance capital in 2022 was not surprising.

The result has been dramatic: risk-adjusted property catastrophe rates spiked by 37 percent at 1 January, with compounded increases exceeding 50 percent over the 2022-23 mid-year renewals. A dearth of capacity at the end of 2022 drove attachment points and retentions higher in an environment of tightening terms and conditions, with some shortfalls. Post-event capital formation lagged historical cycles. For example, the post-Katrina $30bn real-terms injection was about double post-Ian capital raising to date. The reinsurance sector’s premiums-to-surplus ratio now hovers at around 100 percent, a level not seen since the global financial crisis, signalling a tight balance between capital and risk.

Unpredictable climate

Frequent natural catastrophes have added to uncertainty. North Atlantic hurricane activity has been above average in 2023, contrary to expectations usually associated with El Niño. Elevated Atlantic surface temperatures may be partially offsetting expected cooler conditions normally associated with El Niño in the southeastern US. Primary insurers, reeling from some of the worst US personal lines losses in decades, have pulled out of high-exposure, high-volatility states like Florida and California, creating a further dearth of capacity in the direct market, and are demanding better solutions from reinsurers.

From challenge to opportunity: Adding economic value

It is typically during challenging periods such as these when excess returns become possible. After a slow start, ILS funds are seeing renewed inflows, and net new issuance may potentially exceed $5bn by year-end. ‘Asset-light structures’ are adding new channels for alternative capital – although collateral needs careful scrutiny. Capital flowing into vehicles backing MGAs, fronting arrangements and consortia represents a potential revolution, altering the mechanics of risk transfer.

There is a sizeable opportunity for those who can navigate the evolving risk landscape. Assuming a ‘normal’ remainder of the year, given pricing levels and more favourable programme structures, reinsurers stand to see returns on invested capital (RoIC) outpace their weighted average cost of capital (WACC), marking the first time in years that positive economic value can be achieved.

Looking ahead

The industry is at a turning point. Key signals, such as record high pricing and strong demand for capacity, are positive indicators. Questions remain, especially around exposure and volatility given heightened natural catastrophe activity. Reinsurers that can navigate this have the chance to increase value and valuations if they adapt to the changing market. Much will depend on underwriting decisions and effective portfolio management as the reinsurance sector undergoes this pivotal shift. Embracing modernisation, including new underwriting structures now coming into their own, will also be key.