As recently as last year, some were still arguing reinsurance pricing cycles had permanently moderated. But today we’re in the hardest market since 2005. David Flandro explains how it’s happened – and a key factor too few are talking about.

Irma inflation

2017 was the worst year ever. For insured catastrophe losses, anyway. Although the record may soon be broken, that year saw the largest insured catastrophe losses on record, costing insurance companies and state funds upwards of $160bn in inflation-adjusted terms. Yet capacity in 2017 remained relatively buoyant when compared with today, ‘trapped’ capital notwithstanding. Until this year, dedicated reinsurance capital had increased every year since the 2008-09 financial crisis – including in 2017.

The stars had aligned to create stronger sector balance sheets every year during the post-financial crisis period. For one thing, major catastrophe losses were more manageable than had been anticipated. Yes, there are strong counter-examples, like Superstorm Sandy and Tohoku Fukushima, but in the decade leading up to 2017, reinsurer cat loss loads were lower than expected, on average. There were no landfalling hurricanes in Florida for 11 years, for example. The P&C reserving cycle, the source of so much pain in the early 2000s, appeared to have calmed down almost permanently. There was some strengthening from calendar year 2016, but this was extremely shallow compared to the liability crisis over a decade earlier. Finally, and most overlooked, the bond market was on a tear. With quantitative easing at the short end of the yield curve and ‘the great moderation’ continuing at the long end, high-grade fixed income securities – the main investment of most P&C reinsurers – rose rapidly in value, bolstering capital positions.

All of this led to excess capacity and moderating reinsurance pricing. Even as the cycle began to change from 2017-2021 – the result of the confluence of major global events including mounting climate-induced natural disasters, Covid disruption and early signs of inflation – we saw little initial reinsurance capacity contraction. As is evident in the figure below, the primary market started pricing in events almost immediately, while the reinsurance market remained relatively lacklustre – until now.

Global-property-catastrophe-reinsurance-vs-commercial-property-insurance-pricing-–-2012-to-2022-

So what changed? Why has the reinsurance cycle suddenly reasserted itself with higher pricing, falling capacity and tighter terms and conditions? And crucially, what’s coming next?

The asset side

An increasingly obvious factor influencing this relatively sudden shift in pricing – the straw breaking the camel’s back – is the asset side of (re)insurers’ balance sheets. Assets – again, primarily bonds – have been hit particularly hard by this year’s rapidly changing inflation expectations and subsequent interest rate hikes:

 

Bloomberg-global-aggregate-investment-grade-index

In fact, for the first time since the early 1980s, bonds and shares have fallen in tandem, as the market has lost faith in consensus inflation forecasts (chart below) and abruptly switched to higher forward interest rate assumptions early in the year. This has directly impaired reinsurers’ balance sheets – and it’s still happening.

Economists’-consensus-US-inflation-forecasts-vs-actual-–-2019-to-2023E

The bond market drop led dedicated reinsurance capital to fall decisively in the first half, a development which coincided with 25 percent increases in property catastrophe reinsurance rates on line at 1 June. This tectonic shift means that the sector cannot count on the capital cushions that have been so persistent over the last decade. Yes, the alchemy of asset-liability matching means higher yields on today’s securities can offset future reserve inflation (i.e. ‘increasing the discount rate’), leaving SFCRs and BCARs relatively intact. While these are theoretically defensible calculations on paper, investments are impaired now. As the sector enters the next renewal cycle, on the back of Hurricane Ian, with diminished invested assets, solvency and especially liquidity, previous outliers will now be even more vulnerable.

Dedicated-reinsurance-capital-and-global-gross-reinsurance-premiums

Looking to the future

At this point we can safely say that the cycle is not dead. Reinsurance sector pricing is catching up with the primary market and entering the hardest market in at least a decade, with no sign of easing yet. In A Tipping Point, our latest report, we discuss other factors contributing to this hardening market, and how Howden Tiger’s innovative, innovative approach to reinsurance broking can help clients navigate both sides of the balance sheet.