What's impacting the outlook for the global reinsurance market?

What’s impacting the outlook for the global reinsurance market? | Insurance Business New Zealand

Insurance News

What’s impacting the outlook for the global reinsurance market?

Digging into the factors behind rising ‘earnings perils’

Insurance News

By
Mia Wallace

In its most recent analysis, Moody’s Ratings revealed that its outlook for the global reinsurance sector has shifted to a positive ranking. In a media briefing discussing the analysis, Brandan Holmes (pictured left), VP-senior credit officer at Moody’s Ratings attributed this to a variety of factors including increased premiums, tighter policy conditions, good risk-return dynamics and strong investment earnings.

“Overall, what’s helping support tighter policy terms and also stronger pricing?” Holmes asked. “We think it is an upward reassessment of risk and a closer focus on good risk-return dynamics for reinsurers. Supply and demand of reinsurance capacity have also remained more balanced than was the case at the top of previous hard market cycles, which helps reinsurers stay disciplined.”

He noted that the period also saw reinsurers perform well compared to primary reinsurers, which is in large part due to the shift in exposure to small-to-medium-sized events, or secondary perils, from reinsurers to primary insurers. This is combined with the fact that these secondary perils have been very large contributors to overall cat losses in the last few years.

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What’s behind Moody’s Ratings positivity for the sector?

Three key factors underpin Moody’s Ratings’ positive outlook for the sector and its conviction that the favorable conditions will continue for at least the next year – despite the fact that price increases seem to be slowing, and it expects interest rates to start moving down. “Number one is the upward reassessment of risk, particularly with response to the frequency and severity of so-called secondary perils, which the industry has found difficult to model and manage. And this supports ongoing strength in pricing and in terms and conditions.

“Second, there’s been a structural shift of exposure to these smaller-to-mid-sized events, from reinsurers to primaries, and this has really alleviated a lot of the earnings strife that reinsurers faced in previous years. And thirdly, in contrast to the previous hard market cycles, there have been only limited flows of new capital into the sector. So, those three things, we think, will support underwriting profit or at least risk-adjusted underwriting profit, even if prices drift down a bit.”

Looking at how secondary perils – as a proportion of the overall mix of losses – have risen steadily over the last few years, Holmes highlighted how the challenges around managing those perils have led to a higher view of risk. Adding further insight into what’s driving the rising insured losses from those events Joss Matthewman (pictured right), senior director of climate change product management & strategy, emphasized that rather than calling them ‘secondary perils’, it’s more accurate to refer to them as ‘earning perils’. While these perils can still generate big losses, they typically impact insurers’ and reinsurers’ earnings, rather than capital or solvency.

The five factors behind increasing ‘earnings perils’

“There are five factors which are really driving that increase in claims [we’ve seen] over the past few years from these earnings perils, and that includes population migration and urbanization,” Matthewman said. “On migration, we have people moving from low-risk areas to high-risk areas, so we’re just having more people at risk.

“But we also have urbanization. We see that migration is taking the form of people moving to urban centers, and that’s a problem because the footprints from events like hail or tornado are typically pretty compact. So if we concentrate exposure in a single area like an urban center, we get more of an all-or-nothing effect, compared to a more dispersed population across a less urbanized area. The other… problem with urbanized exposures is that the built environment is problematic for rainfall, runoff and drainage, so that exacerbates flood losses in those areas.”

The second challenge is around economic inflation. The average cost of reconstruction and construction is going up globally, so that will impact reconstruction costs from these events. “But we also have social inflation, so changes in claims behavior which are due to a combination of different social factors,” Matthewman said.

The challenge there is that some of those may be emerging trends while others may be repeating or non-repeating phenomena, which may or may not be seen again depending on legislative changes preventing them from reoccurring. However, he noted that the effectiveness of legislation can vary, and it does have to be tested, usually by the next event that the market sees.

The third factor driving the earning perils increase is around building vulnerability which he highlighted is a difficult consideration because, as building stock ages, it becomes more vulnerable. “So we expect to see an increase in losses over time from that,” he said. “But as we get newer buildings constructed, or buildings which have been repaired, perhaps following a recent event, those tend to be less vulnerable. So, there is some competing impact here and it’s not immediately obvious which of those will win out.”

Changes in building practices might also be driving some of this increase, he said. For example, 30 years ago, not many roofs had solar panels installed but that’s an increasingly common building practice today, which is exacerbating damage from wind and hail events.

The fourth factor centers on insurance take-up. The growing take-up of insurance is a positive thing but it’s naturally going to grow the overall losses seen by the industry. That will be particularly compounded if this increase in take-up rates occurs in those areas which have a greater population migration and urbanization.

Understanding the role of climate change

“The fifth one is climate change,” Matthewman said. “The question is, to what degree, after all of the above, does climate change drive that signal that we’re seeing? And it’s really not as primary a driver as the [above] facts. Generally, the impact of climate change on catastrophe perils is complex and it’s highly uncertain, and that’s due to the relative rarity of those events. Across a geography or a peril, we may only have a handful of these earnings peril events across a period of several years.

“So it’s really hard to disentangle climate change trends from that natural year-to-year climate variability. We do have greater confidence in some perils versus others, and even within individual perils. So for example, for convective storms in Europe, we can have more confidence in the impact of climate change in some areas within that region than others. Still, overall, we do expect climate change to be a much smaller contributor to those loss increases, which we’re seeing in those earning perils compared to the previous four factors.”