Cat capacity crunching, but Ian still within risk appetites: Peel Hunt

A capacity crunch in property catastrophe reinsurance is becoming “ever more likely” according to analysts at Peel Hunt, but importantly they highlight that even at the estimates for the level of industry losses it will cause, hurricane Ian should still fall within the sectors risk appetite.

Peel Hunt’s analysts opt for an industry loss mid-point of around $50 billion for hurricane Ian, which at this stage seems about right, given the cat risk modeller estimates tend to average $40 billion to $60 billion.

Even at the higher end of industry loss estimates, so the $74 billion of RMS’ range, the loss from hurricane Ian still falls well-below peak industry loss scenarios for Florida storms.

Because of this, Peel Hunt’s analyst team say hurricane Ian falls “well within the re/insurance sector’s risk appetite,” which is an important fact to remember when making pronouncements of a gloomy future for capital’s appetite for natural catastrophe risk.

Hurricane Ian falls well within the range of possible, or modelled, market losses for the catastrophe bond market as well.

Scenario modelling of major Florida hurricane events have suggested the potential for massive draw-downs of cat bond risk capital, with a huge percentage (60% or more) of the market’s outstanding risk capital feasibly exposed to a single storm that hits the southeast.

So far, in the case of hurricane Ian, it seems roughly 10% of the cat bond market is deemed exposed, but cat bond funds are down by an average of just over -5%.

But that is still the mark-to-market hit, not the actual losses as these haven’t crystalised yet.

So, it seems unless we see a significant wave of litigation and loss creep, Ian could be anticipated to result in a hit to the cat bond market well below 10%, once the final bill for that segment of the insurance-linked securities (ILS) market is counted.

For traditional reinsurers, Peel Hunt’s analysts believe that any additional losses this year will “drag down RoE’s”, as the reinsurance sector has already faced a tough year with losses due to the Ukraine war, other catastrophe and weather events, loss creep from previous events (the French storms for one) and financial market volatility that persists with the unrealised bond losses it has driven.

While the ILS market has not faced so many other significant events in 2022, the problem here is the fact losses are coming every year, eroding performance and resulting in disappointment for investors in some strategies.

Pricing will help gooing forwards, or course, as too will the very important re-underwriting of portfolios. But that likely won’t make the job of investor relations any easier for ILS managers at this time.

Losses falling within the risk appetite of the industry is one thing. But experiencing an elevated frequency of those losses, while feeling there’s been a lack of compensation for bearing them in the past, is another thing entirely, when it comes to investor confidence.

Peel Hunt now forecasts a growing “capacity crunch” for the property catastrophe reinsurance market, something that has really been building for over two years.

A “retrenchment of traditional and third-party (ILS) capital” is a key driver, although it is also worth considering that just two years ago the industry was still bemoaning the availability of excess capital in the space.

The analysts say this “makes a significant increase in property catastrophe reinsurance rates ever more likely next year as the 1 January renewals loom. Reinsurance rates not only have to adjust for inflation, but are also impacted by a demand/supply imbalance.”

They added, “Rate rises should further boost underlying underwriting margins across the sector and improve the ability of the specialty (re)insurance industry to absorb losses.”

Which, of course, goes for the ILS market and catastrophe bonds too, where rates are also going to rise at a clip after hurricane Ian.

Brokers aren’t immune to the effects of a decline in capacity either, as for one their volumes may fall, while they could also struggle to satisfy clients that have come to expect access to capital.

It’s no surprise then that facilities are discussed. But for capital this isn’t always the optimal mechanism for deployment.

If the industry really wants to rebuild capacity in an efficient manner, it could look to marketplace technology and allow capital to dictate the price and terms, rather than following-form.

For the ILS market, the fact hurricane Ian falls within risk appetites won’t make upcoming discussions with investors any easier, given the consecutive years of losses experienced.

There is a need to demonstrate the ability to deliver on promises, in terms of returns, but also in how loss events impact an ILS strategy and what managers have been doing to moderate their impact and try to deliver returns across the market-cycle.

Again, this makes the re-underwriting that has been ongoing across ILS all the more important, but key now for managers to be able to evidence the difference it has made to the portfolios.

But more important still is securing risk commensurate pricing going forward, that can, across the portfolio and the cycle, cover loss-costs, cost-of-capital, expenses and a margin. That goes for the traditional and ILS markets alike.

Read all of our coverage of hurricane Ian, and our analysis on the potential market losses, here.