Any self-respecting insurance or reinsurance expert can rattle off a long risk of reasons for hard or hardening reinsurance markets. They fail to mention, however, that constant changes in cover, retention and price (or premium) are part of the elaborate machinery that ensures the long-term sustainability of the global re/insurance industries. Each of these components is a lever that reinsurers can pull or push in response to the insured losses arising from natural catastrophe and other perils.
The impact of reinsurers’ decision-making on insurers and customers was up for discussion at the 30th Insure Talk webinar, billed as South Africa’s go-to virtual conference for sharing insurance industry “news and views”.
Willie van Graan, chief underwriter and reinsurance officer at Old Mutual Insurance, started his talk by reminding the audience of the industry’s raison d’être: “In its simplest form, insurance is about the pooling of risks; the premiums of the many pay for the losses of the few,” he said.
Reinsurance expands this concept from the customer realm to the insurer realm, allowing insurers to pool and share their risks with reinsurers, globally. Together, insurers and reinsurers enable risk diversification, while global reinsurance markets serve as an important layer of protection for domestic financial systems. The value of reinsurance is evident in the aftermath of one of South Africa’s most significant natural catastrophe loss events, the April 2022 KwaZulu-Natal (KZN) floods.
“An insurer like Old Mutual buys reinsurance for aggregating losses like the KZN floods … reinsurance helps us to diversify risks and keep the cost of insurance lower for our end user,” Mr Van Graan said.
Climate change was singled out as one of the biggest risk factors for the insurance / reinsurance industry globally circa 2023 with the number of significant natural catastrophe loss events on the rise since around 2012. This newsletter will not dive into the detail except to comment that the last 12 months have had a “natural catastrophe a minute” feel to them.
Droughts, earthquakes, floods, hailstorms, hurricanes, tornadoes, wildfires, winter storms; you name the peril, insurers and global reinsurers have had to step in to cover the loss. And the impact of the rising frequency and severity of climate change-related extreme weather events is visible on the chart of the 10-year moving average for global natural catastrophe losses, which is trending sharply higher since 2015.
Having navigated some of the basics – and offered some background – the presenter turned his attention to an insurer’s experience of the January 2023 reinsurance renewal window. Mr Van Graan commented that reinsurers were pushing their insurance clients to take on “more risk at the bottom” by using three distinct mechanisms: Attachment, coverage and pricing. Attachment (or retention in the insurer’s lingo) is the limit that a reinsurer expects an insurer to “cover” before the reinsurer’s cover kicks-in; and this attachment level is rising. For example, prior to the April 2022 KZN floods, a reinsurer might have stipulated a ZAR100m attachment for catastrophe (CAT) property cover; but during the January 2023 renewal window, that attachment lifted to R200m, R300m or even R400m.
Cover or coverage refers to the perils or risks that the reinsurer is prepared to indemnify. “In South Africa, we traditionally bought all perils cover in our CAT programmes [but] the reinsurers have started pushing back against that,” Mr Van Graan explained. “One of the things that the reinsurers have focused on this year is what we refer to as grid collapse or failure, which is a systemic risk that reinsurers do not want to assume”. It is important to note that local insurers could still elect to offer cover for grid collapse, but that covering such risks becomes too costly without the safety net of the pooling offered by reinsurers. “It is impossible for us to put a price to grid collapse because it is not clear what our total exposure will be,” he said.
Grid collapse is the type of systemic risk that insurance was never designed to compensate for. If South Africa were to suffer a catastrophic grid collapse, then all insureds countrywide would be out of pocket, rendering the “many premiums for few losses” insurance underpin moot. PS, similar factors were at play when global reinsurers faced pandemic-related business interruption claims following Covid-19 in 2020-2021.
The discussion around a reinsurer’s premium or pricing decisions is somewhat more complex due to the insane number of inputs that must be considered. Traditionally, reinsurers price their programmes based on their CAT modelling; they determine the extent of losses they are likely to incur and then spread these losses (plus underwriting costs and margins) across their customer base.
“Stressors in the CAT market, especially in North America, has resulted in pricing and structural changes [that were] unsupported by technical considerations,” said Mr Van Graan. “Some reinsurers were asking for technical increases in price and retention way in excess of what their modelling indicated.”
This diversion from traditional pricing methodologies caused allocators of capital to redeploy to more lucrative reinsurance markets, causing imbalances in capital supply and demand globally. Capital flows have also been affected by the global inflation and interest rate theme, with investors diverting cash towards the higher risk-free-rates on offer from opportunities in financial market rather than the riskier CAT reinsurance market.
“Reinsurers and their capital providers were very cautious to deploy new capital as we entered 2023, and that contributed to a constrained reinsurance market,” said Mr Van Graan.
To conclude, he commented on the effect of higher attachment (or retentions) and rising reinsurance reinstatement costs on domestic insurers. “If you have a two to three times increase in retention, it means that you, as the insurer, have to hold more capital to satisfy the regulator; if we cannot get protection from the reinsurance market, we have to hold that capital ourselves.”
And that has a knock-on effect on the insurer’s cost of capital and the pricing that it takes to market. For customers, the bottom line is that a hard reinsurance market translates into higher premiums and reductions in cover.