Innovate to narrow frequency / secondary peril reinsurance protection gaps: Aon

Concerns are being voiced over the way reinsurance capital has moved further away from secondary perils, as well as the reduction in available aggregate coverage, which perhaps led Aon to state in a recent report that this is a critical area where innovative efforts may be able to fill some of the reinsurance protection gaps that have appeared.

The concerns over gaps that have appeared come from both the broker and cedent side, where some view the shift away from frequency and secondary peril exposure as detrimental to the reinsurance coverage offering.

It’s true that protection is now much more limited for the so-called secondary perils, as well as for frequency catastrophe events, given the move away from aggregate covers.

But reinsurance and ILS capital providers have taken on the burden of increasing loss activity and higher loss quantum, linked to these types of often weather-linked perils, so in a world where climate is a growing concern the pull-back from this is perhaps understandable.

All of which means there is an opportunity for a constructive market response, to try and reintroduce some coverage options, or even entirely new and complementary risk transfer products, that can help cedents, largely insurers, but in some cases reinsurers too, to smooth out some of the volatility they are now retaining and suffering.

For insurers, with attachment points raised at reinsurance renewals over recent years, while terms and conditions have tightened and aggregate cover capacity been reduced market-wide, the reality is that many of these weather and catastrophe losses, dubbed secondary or frequency, are now being entirely retained.

In its recent reinsurance report, broker Aon explained that, “Secondary perils continued to drive losses in the first half of 2023, with convective storms, wildfires, hailstorms and flooding in the US and Europe.”

Explaining that, “Changes to retention levels at mid-year and January renewals have seen reinsurers move higher up programs and away from large frequency losses, including SCS and wildfires, which have seen reinsurers reporting fewer ceded losses in 2023.”

In fact, Aon believes that the first-half results of the reinsurance industry, “Provide early evidence that the market has successfully distanced itself from frequency catastrophe losses and secondary perils.”

Going on to state that, “Ceded losses have significantly reduced as a result of the retention increases and shift away from providing aggregate catastrophe protection.”

Which is all very positive for the results of the reinsurance market and returns of the insurance-linked securities (ILS) sector.

But, for the cedents providing ground-up protection to their clients, the increasing pain they are feeling from frequency and small often weather-linked catastrophe event aggregation, is stressing some of their business models, it seems.

All of which has also been a factor in some major insurers decisions to pull-back, or exit, certain regions of the United States as well. A trend that could expand to other countries and regions, if the reinsurance capital industry continues to pull away from frequency exposure and secondary peril loss events.

Aon acknowledges that the nervousness over secondary peril exposures, among the reinsurance capital providers, is not going to go away at the renewals, saying that, “Concerns around the impact of secondary perils will likely maintain discipline at the lower end of programs for the foreseeable future.”

But the broker does feel there is room for an innovative response from the industry, to this challenge of providing more reinsurance protection to assist cedants that are being affected by the additional volatility they are now absorbing from these types of loss events.

The reduction in secondary peril cover and pull-back on aggregates was perhaps most noticed at the January 2023 reinsurance renewals and looking forward to January 2024 it’s clear Aon hopes its clients may experience slightly better conditions, perhaps with even more, or new, options for coverage becoming available.

“The increasing frequency of ‘secondary’ peril events, such as severe convective storm, may drive insurers to seek innovative solutions to the protection gaps that they experienced in the first half of 2023,” Aon said.

Of course, solutions at the frequency and volatility end of the tower are not a one-size-fits-all solution, as underwriting track-records will really matter here.

The broker noted the “heightened secondary catastrophe loss activity in Europe” as one area of particular relevance for January 2024 renewals and it’s clear Aon hopes for less fraught renewal for its EMEA clients this time around.

While also hoping for a response from the reinsurance community, to try and help insurers with their frequency issues.

Aon said, “We expect reinsurers will now work with insurers and their advisors, using data and analytics, to innovate in this critical area going forward.”

The area of secondary peril protection and aggregate coverage is not only a reinsurance protection gap, but also exists in retrocession markets too.

Risk capital providers lost their appetites for providing the kind of low-down protection many companies had got used to being abundant, cheap and available, which has driven a search for alternatives that now seems to be intensifying, to a degree.

As we’ve explained before, we’ve heard of initiatives where brokers have been working with capital providers to try and establish where the appetite for lower-down reinsurance and retro, as well as aggregate protection, might be most needed and whether there are alternative risk transfer products, triggers, or structures, that could help to reintroduce an element of protection to the areas where these volatility buffers are most needed.

The resurgence of interest in sponsoring sidecars may be a slight reflection of this, as in some ways they can provide a valuable coverage complement to the traditional reinsurance tower which is able to absorb some of the volatility, on the frequency side.

But, we’re yet to hear of any concrete ideas that can really help carriers begin to shed some of the additional risk they are now retaining and in fact, the reinsurance and ILS markets we speak with, are aligned in their desire to maintain the new status quo.

As a result, innovation is definitely required, but it’s going to take some particularly out-of-the-box thinking to provide the kind of reinsurance or retro protection some are hoping to find, especially in a hard market like we see today.