Property cat: toughing it out
It is a tough time to be a property catastrophe reinsurance underwriter. Cedants’ capital positions have strengthened in recent years encouraging them to retain more risk, reinsurers’ balance sheets have grown while demand has remained relatively static, and now third party capital has gone from a stream to a flood, further exacerbating already difficult conditions.
A benign few years—particularly in the US—have hardly helped matters. As James Few, CEO of Aspen Re explained, conditions are a creating a “battle of the signings” in which the ultimate winners are the buyers, as traditional and convergence capital have slugged it out. The result has been a marked decline in rates and fears that the bottom is yet to be reached. As Konrad Rentrup, CEO of Hannover Re (Bermuda) outlined, “Rates have softened markedly and very fast. Conditions are remarkably soft right now.”
Few explained that reinsurers and the wider market are having to accommodate both an increase in their own capital positions and the new permanence of convergence capital that in the past rarely reached such meaningful levels. “Competition from convergence capital is significant and we believe that the landscape has changed materially as a result,” he said.
The impact on the pricing dynamics in property catastrophe reinsurance has been significant and there is a sense that convergence capital is increasingly comfortable in the space. Pete Cangany, senior partner at EY Bermuda, said that despite declining returns, there continues to be a flood of third party capital entering the property catastrophe space, exerting continuing downward pressure on rates.
The question is whether further downward pressure will encourage traditional players to exit the space altogether. Cangany felt that some underwriters are already at the point where “discipline will mean they will hold their pen back”, but said that the line remains attractive to Bermuda and international writers. While thin, rate adequacy has not yet reached the point where there has been a marked exodus from property catastrophe, although Few did express concern that should rates decline still further there would be cause for concern.
“While plenty of cat business remains attractive, that won’t be the case if rates continue downwards with the same momentum. We are concerned about the trajectory, because as a volatile, capital intensive line, cat deserves a fair price,” he said. While there has been a slowing in the rate of third party capital entering the space, and some realignment away from property catastrophe by traditional players as a result of conditions, supply:demand dynamics have not been changed materially yet. As such, the trajectory appears to indicate further downward movement.
Terms and conditions
Terms and conditions have likewise come under pressure as insurers look to incrementally add value to their programmes. As Rentrup explained, many are “playing around with reinstatement features”, asking for multi-year deals, the extension of hours clauses or rolling forward more of their programmes. While he described push-back on some of these requests, it is apparent that many reinsurers are willing to consider such changes to terms and conditions in order to win signings.
Tom Meyer, chief underwriting officer at Aspen Bermuda, said: “Aspen is relatively comfortable entertaining current requests such as extended hours clauses, multi-year transactions and cascading layers so long as we can rate for it. What we don’t want are last minute requests as they time-bar us from underwriting with due diligence.” Reinsurers are evidently considering every lever to remain relevant. Again, insurers will be the major beneficiaries, but there are challenges associated with further rate declines and term changes.
Rentrup cautioned that cedants need to take a long-term view regarding rates, terms and conditions arguing that those who are pushing strongly for significant rate reductions or contract changes are unlikely to achieve or sustain lasting relationships. “I am not saying that cedants aren’t going to ask for rate reductions as there is plenty of capacity out there right now, but who knows how the market will develop?” he said.
“This kind of rate exploitation is most common among smaller cedants, but they are also the ones that will pay the most when the market hardens.” He cautioned against the market pushing too hard for further rate developments that might force some traditional players to walk away.
Bill Miller, director-actuarial at KPMG, agreed that conditions have encouraged insurers to be more opportunistic in their buying, but cautioned that “any uptick in short-term buying behaviour among insurers may not necessarily lead to long-term demand”. This is exactly the kind of opportunism that reinsurers need to be wary of, he said, particularly in the face of the battle over signings and a focus on building long-term relationships that might not materialise.
Miller added that traditional reinsurers in the property catastrophe space are facing “a tough call” regarding how hard they want to compete, how much business their third party capital subsidiaries can take on, and whether they can compete with the competition. The perfect storm continues to deepen.
A dynamic response
Developments have helped to create a number of dynamics within the property catastrophe space. Rate reductions and rising retentions have encouraged a rethink among insurers and reinsurers regarding their approach to the market. As Rentrup outlined, larger cedants are consolidating their panels, and looking at the rating, line size and capabilities of their reinsurer partners.
“Larger cedants are looking for players with significant market share and capabilities with whom they can develop a long-term partnership going forward,” he said. They are looking for partners who can deliver value to their relationships beyond simply price, with capabilities across geographies and lines, as they retain more business and hand-pick the best reinsurers. Rentrup said that this was regarded as a positive development by Hannover Re, which is happy to develop relationships on as broad a basis as possible. “With a broader relationship it is easier for you and the client to digest the hiccups that inevitably appear along the way.”
Few agreed that the buyer’s market is creating increased demand for multi-line and multi-geography solutions. This tends to favour well-diversified players who can deliver casualty and specialty solutions and international property catastrophe coverage to increasingly sophisticated cedants.
“Our aim here at Aspen is to cross-sell cat with specialty and casualty products to our core global client base. That strengthens our relationship and enables us to compete for signings in an over-served market.”
Meyer added that when discussing reinsurance spending with clients it is a rare occasion when other lines aren’t discussed. “Cat might be relatively easy to place, but they might be having a headache with their aviation programme—and that is where their core reinsurance partners step up to support them.
“Solutions are not only about cat, it is about offering clients more than that,” he explained. Few added that Aspen also delivers in-depth analysis of catastrophe risk to clients, who value the R&D that sophisticated reinsurers can bring to bear in their relationships.
“Traditional players are fighting back—against conditions and rising convergence interest—creating innovative solutions and products that ILS players cannot easily compete with such as reinstatements, multi-line and aggregate deals,” explained Craig Redcliffe, partner at EY Bermuda.
He said that by competing solely on price rated players cannot hope to overturn pricing dynamics and the advantages of third party capital in the space, but by leveraging their relationships, analytical capabilities and risk systems they can aim to differentiate their offering.
“You don’t want to be competing in a commodity-based business because ultimately it is a race to the bottom,” said Redcliffe. It will be by delivering value that reinsurers can prove their worth.
A third way
Not that rated players have not looked to third party capital sources to complement their positions in property catastrophe. All but one of the major players in Bermuda have a convergence vehicle and most have been extremely active in the property catastrophe space.
Few said: “It is important to have access to all forms of capital. We believe that there are certain products where new capital is most effective and others where traditional equity capital is most appropriate. We positioned ourselves through partnerships with third party capital that began in 2009 and includes the formation of our asset management company, Aspen Capital Markets, in 2013 to bring all available solutions to our customers.”
He added that in the property catastrophe space, third party capital can provide an edge and that traditional players should consider all their options as they look to deliver capacity and capabilities. “For alternative capital, property cat is not a peak exposure and it can be priced accordingly. It is not a driver of capital needs, rather it is a diversifier, and therefore there is not the need for the same margins.”
Meyer added that there is also rising expectation among both brokers and clients that reinsurers will be able to bring third party capital to bear. “If you don’t have that capital market position you are already severely compromised in what is an extremely competitive marketplace.”
While convergence capital continues to exert pressure on pricing in the space, Few said he was not convinced the pace of the current downward trend is sustainable. “I suspect the rate reductions driven by present over-capacity will decline,” he said.
With many of the third party vehicles backed by traditional players, it seems that at the group level they are unlikely to continue to chase rates to the bottom, even considering the lower cost of capital in the convergence space. Rentrup concurred, questioning whether, in the long run, reinsurance will be regarded as attractive to alternative capital as return on capital comes under increasing pressure. This might just be the good news that traditional players need in the space as pricing has in some instances edged towards the walk-away point.
Wind and water
While there has not been a grand exodus from US wind, there has been a closer examination of alternative lines and geographies as a result of present dynamics. As Cangany explained, improved data globally means that re/insurers can distribute their capital more widely than before, seizing upon opportunities internationally and by line. They are also looking to benefit from “more rational pricing” in other markets as they look to put the dynamics of US property catastrophe behind them.
Meyer added that Aspen is seeing a broadening of market focus as a result of pressures. “Diversification in cat is a given, but we are also seeing a huge push into other classes—both casualty and specialty—by line and geography. In this environment you have to access every lever you can pull.”
Few argued that “While new capital has not manifested itself in other lines to a level where we are overly concerned, we are preparing for it.” Rentrup cautioned, however, that property catastrophe is not the only area where the market is seeing rate reductions within reinsurance. Market conditions for reinsurers are almost universally soft, prompting multi-line re/insurers to concentrate their attentions in primary lines. Alternatives are not universally more attractive than property catastrophe.
One risk that has the potential to complement underwriters’ ambitions in the US is flood, particularly as states edge towards a private solution. While the neutering of the Biggert-Waters Act has slowed the pace of reform, there is increasing talk of—and movement towards—a private solution.
As Few outlined: “We believe that the private market provides a better product and a stronger solution for the consumer than the government does in the flood space. We have been supportive of moves to bring insurable risk into the private market.”
Rentrup said that key to unlocking the risk will be reaching risk adequate pricing, something that remains, for now, politically unpalatable. He warned however that with states and the federal government retaining flood risk on their balance sheets, “deficits have the potential to go through the roof”. Few added that private solutions can also deliver greater fairness by getting those in high-risk areas to pay for their coverage, rather than its being spread right across the tax base.
Despite the will to take on more flood risk, there remain issues around the granularity and availability of data. As Few conceded, “Data on flood can be challenging and it is a risk that needs to be individually underwritten.” Rentrup agreed that there remains a high level of uncertainty associated with flood risk, which makes it less attractive to catastrophe writers than wind. Nevertheless, he sees greater efforts to wrestle with data granularity and rate adequacy.
As Miller outlined, “There is a big move right now to enhance flood modelling and while the analytics may take a time to catch up with wind, the capacity is certainly there.” For the time being, however, flood will remain an add-on to wind—one that has potential, but is yet to be fully grappled with and priced by the private market.