New problems, old solutions

Significant pressure from convergence capital continues to bear down on the reinsurance market as a whole. But this pressure is most telling of all on US Gulf coast property cat underwriters.

These lines of business are the softest of any in the reinsurance market; some say pricing has never been this low for this exposure.

This is according to Bill Miller, head of actuarial at KPMG Bermuda, who explains that 70 percent of the ILS market is focused on this peril—it is therefore primarily driving this pressure.

The perception is that the models are very mature and accurate. “So you have a pretty good handle on what the expected loss and the probability of attachment for a given cat bond is,” says Miller.

In this sense, the market has become somewhat commoditised, he says, and the fact that there has not been a significant cat event in recent years has fuelled this commoditisation.

The intense competition presents a dilemma for underwriters. “They have to make a difficult decision on which deals to keep and which deals to walk away from,” he says.

He also believes that terms and conditions are eroding faster than rates. It is easier for an underwriter to ‘give in’ on the terms and conditions while trying to prevent revenues from going down as much.

And while analytics can easily tell underwriters which deals are adequately priced and which are not, the decision on whether to pull away remains a business judgement.

“It’s definitely a difficult thing because once you get off a programme, it’s sometimes hard to get back on it,” says Miller.

“Companies really need to be thoughtful about making sure they don’t concentrate too much on their exposures for any one unmodelled risk.”

He believes that this pressure will persist into 2015. The second quarter of 2014 was a record quarter for ILS placements, yet Miller says that the influx may slow down slightly in the near term relative to the record levels it has hit recently. “It’s going a little too fast for the capacity,” he says.

Despite this evaluation, Miller believes that medium-term capital will flow in steadily, and hedge fund and pension fund managers will remain interested in entering the ILS space.

“There are more innovative ways for them to get into the market now, many of which involve not just the property side but the casualty side as well,” he says.

A big question is how these types of investors will react if a large cat event occurs. It may represent a reality check for some. “On the other hand this could potentially cause rates to become more attractive as well, so I think convergence pressure is here to stay and will continue to press forward,” says Miller.

Alternative routes

Miller also notes that the difference between insurance-linked securities (ILS) and traditional coverage is blurring. Many forms of ILS are now much more flexible than they were in the past. “It might typically be a three-year cat bond but they adjust the terms after each year,” he says.

This has been helping insurers to fit these alternative vehicles in better with the traditional reinsurance vehicles on their panels, keeping everything in sync.

Interest in these ILS vehicles will persist, he believes, as the products mature and become more flexible and as insurers understand them more. “They want to know how they can help their business, and how they can fit them alongside their traditional programmes.”

Some Bermuda players may be looking to diversify away from the US property cat market as ILS capital drives down rates. Miller sees a significant movement into emerging markets and business lines such as cyber risk and terrorism. “They’re still committed to the US market, but probably as a whole have reduced their market share pretty significantly there,” believes Miller.

Some Bermudans are also seeking more exposure in the US casualty market. Miller says there is a perception that underwriting results have not improved sufficiently to reflect the low investment yields on long tail lines—something that has hindered reinsurers.

“But generally, the US primary casualty market has been very favourable in terms of their results and cost trends, which have been fairly benign,” says Miller. This could be a way for Bermudans to diversify while remaining in the US.

He adds that there is also a trend developing whereby companies are looking to reinsure unmodelled risks as modelling capabilities continue to evolve rapidly. “Unmodelled risks are definitely going to be something we talk about more when considering this diversification trend,” he says.

“Companies really need to be thoughtful about making sure they don’t concentrate too much on their exposures for any one unmodelled risk.”

Some severe cat events have caused modellers to realise that they have to dramatically recalibrate their models, and despite things being quiet on this side for a while, “they’re always a wildcard because that can have a sweeping effect on companies’ capital needs,” says Miller.

Bill Miller is head of actuarial at KPMG Bermuda. He can be contacted at: billmiller@kpmg.bm