Real Estate Catastrophe Reinsurance Entering a Real Hard Market

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This year was full of challenges. Natural disasters related to climate change have increased in frequency and headline inflation has reached levels not seen in decades. Interest rates have risen significantly and Europe has witnessed the outbreak of another war. The COVID-19 pandemic could break out again this winter. How will the global reinsurance industry perform in such an environment?

Climate change will continue to affect the frequency and severity of natural disasters, leading to rising costs for industry. In the first six months of 2022, insured losses were $39 billion, 18 percent above the 20-year average, Aon said. Floods in Australia and Storm Eunice in Europe were the two most expensive events. The hurricane season continues in full swing, with possible new claims as a result. This year fits in nicely with a trend of increasing claims for natural disasters over the past five years. The high level of these claims has led to gains volatility in the reinsurance sector and raised the question of whether real estate catastrophe risk pricing has been modeled and priced.

As a result, a growing number of reinsurers have reduced or even withdrawn their capacity to cover real estate disasters. The retrocession capacity has also decreased, limiting the ability to pass on catastrophe risks to financial investors. The industry is close to entering a real hard market where the demand for real estate disaster coverage will not be fully satisfied. This is most visible in Florida, but also affects other regions, such as Australia. Reinsurers are likely to continue to reduce capacity for the real estate catastrophe business in 2023.

A period of two years or longer with headline inflation significantly above the 10-year average poses a risk to reinsurers as claims developments become less predictable. Margin pressures are first visible in the real estate sector, as rising repair and construction costs can put pressure on margins if price increases do not keep up with claim inflation. However, longtail casualty lines may suffer more due to the compounding effect of multi-year inflation, magnifying the effects of social inflation, leading to significant amplification of the accident and liability reserve and price increases from 2018 to 2020. cases can weaken the capital base and thus the credit profiles of reinsurers can develop.

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Prudent reservation standards and prudent underwriting practices are important steering tools to manage the inflation risk of claims. Since pricing discipline is relatively weak in claims, Fitch Ratings sees an increased risk that the sector could act too late to counter rising claim inflation. We are less concerned about real estate investments, given the current high price discipline. Investments can also partially protect income from high inflation. In particular, inflation-linked bonds are sometimes used by reinsurers to hedge inflation risk, but rising interest rates will generally contribute positively.

War in Ukraine

The war in Ukraine is a medium-sized catastrophe that mainly affects specialty lines such as aviation and shipping, political risk, trade credit and cyber insurance. On average, reinsurers have reserved about 2 percent of net earned premiums as claims reserves for potential losses related to the conflict. While direct exposure is limited, sanctions imposed on Russia will affect a larger proportion of reinsurers’ business portfolios. The ultimate losses are likely to remain unclear for years to come, as lawsuits with cedants and their clients over which risks are covered will take some time to settle, even if the war ends soon. Earlier this year, reinsurers relied primarily on the reactivity of their cedants to mitigate potential claims by withdrawing coverage as soon as legally possible.

Life and health reinsurers will still be dealing with excess mortality claims related to COVID-19 in 2022, albeit at a lower level than a year earlier. While immunity levels have continued to increase, the risk of new, more dangerous variants remains significant. We therefore expect claims for additional deaths from the pandemic to continue to decline, but remain significant over the next 12-18 months. Technical margins will continue to be under pressure as mitigating measures, such as price revisions or treaty cancellations, are difficult to implement.

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Social inflation still unremarkable

However, the situation is not as bad as it seems at first glance. In 2022, the reinsurance market will have hardened for the fifth year in a row. Premium increases accelerated after a temporary slowdown during the renewals in January 2022. Real estate lines saw the most significant price increases in response to the increasing severity of claims due to the factors described above. Price changes in non-life insurance were more measured as reinsurers allocated more capacity to this activity. The industry considers prices to be adequate and social inflation has remained inconspicuous for the time being.

Claims inflation will remain high in 2023 and reinsurers are very keen to protect their margins. As a result, further price increases and higher limits in real estate lines are likely to continue in 2023 to counter upward pressure on claims severity and frequency. Non-life prices are likely to remain stable as more reinsurance capital is allocated here.

Strong premium growth

In addition to price increases, the demand for reinsurance protection is also growing against the background of increased macroeconomic and political uncertainty. The global reinsurance industry is positioned for strong premium growth in 2022 and 2023. While a slowdown in global economic growth could negatively impact some industries, such as auto insurance, trade credit or construction, most insurance is less sensitive to economic activity.

Interest rates have risen in response to higher inflation, reaching levels not seen since 2014. Reinsurers benefit from higher reinvestment returns, which in some cases have already exceeded average portfolio returns. We expect revenues to improve in 2023.

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Higher interest rates have resulted in a shrinking capital base in the reinsurance sector due to the accounting for unrealized capital gains on bond portfolios. According to Aon, traditional capital fell by $31 billion to $548 billion in the first three months of 2022. However, accounting standards, such as US GAAP and International Financial Reporting Standards (IFRS), do not provide a complete economic picture of capital.

Looking at standards that do, such as those applied by regulatory authorities, we find that capital adequacy improved on average in the first half of the year as a result of rising interest rates. Against this background, some listed reinsurers have begun to repatriate capital to their shareholders through share buybacks or special dividends. At the moment we are not concerned about capital adequacy in the sector. For most industries, the availability of traditional reinsurance capital will remain sufficient to meet demand in 2022 and 2023.

Alternative capital remains a strong pillar for the global reinsurance market. Capital inflows into the alternative capital space will remain strong in 2022 and 2023, as insurers and reinsurers increasingly place peak risks on institutional investors. The alternative capital market continued to grow, reaching $97 billion at the end of March 2022. The catastrophe bond market continued to gain market share thanks to transparency and flexibility for investors. At the end of 2021, cat bonds represented 32 percent of the alternative capital space, compared to 29 percent a year earlier.

Global reinsurers are currently facing a range of challenges, including inflation, climate change and political uncertainty. Still, demand for reinsurance protection is growing, pricing discipline is high and interest rates are rising. Given all those challenges and opportunities, Fitch believes global reinsurers can keep their underlying earnings at 2021 levels for the next 12-18 months. As the management of the reinsurance business will become increasingly demanding, we expect a growing divergence in strategies and a wider spread of results.

Catastrophe Reinsurance Price Trends Real Estate Market New Markets


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