How COVID-19 and cat events shaped the 1/1 renewals
Reinsurers’ approach to the January 1 renewals was not only influenced by the impact of COVID-19 on the various classes of business, but also by a year of catastrophe frequency pointing to another year of combined ratios north of 100 percent. As a result, there was a divergence in approach, according to Peter Gadeke, executive vice president at Willis Re Bermuda.
“A number of reinsurers looked at reducing exposure to manage volatility (against rising retrocessional costs) across all lines and ensured that solvency ratios were managed,” Gadeke says.
“Reinsurers were quick to lay down a marker that inclusion of these perils would be non-negotiable.” Peter Gadeke, Willis Re
“Others saw potential rate improvement as an opportunity and raised capital to take advantage of this. These conflicting approaches were largely formulated based on speculation and expectation as the market loss position was still severely under-developed, and transparency was tough to obtain.”
He adds that this was particularly prevalent in retro as the market of last resort: some retrocessionaires strongly stated their reservation of rights, seeking clarity on contract language, particularly where they sold coverage as named or natural perils only.
“Generally, there was a sense and anticipation that there was an opportunity to address prolonged under-pricing of the product,” he says.
Gadeke highlights a number of factors that influenced the renewals landscape. Through the summer and in the run up to January 1, indications were that demand would increase while supply could be adversely affected due to trapped collateral, bringing the assumption of an upward rate movement to varying degrees across product.
“In retro, the potential of trapped collateral and investor fatigue pointed to a hard correction in pricing, significant focus frequency covers and setting adequate retentions.
“This hypothesis was garnered from a recent increase in cedants buying additional cover mid-term 2020 to manage US wind exposures,” says Gadeke.
“With the COVID-19 impact confined to sentiment and speculation around legitimacy, how to manage systemic exposures going forward became the focus—some things just cannot be priced for. This spread to cyber, and reinsurers were quick to lay down a marker that inclusion of these perils would be non-negotiable.”
Gadeke notes that reinsurance buyers were generally consistent in the way that they bought, in both product and limit, and were looking for incumbent reinsurers to maintain their positions. With the market hardening, some reinsurers looked to consolidate around what they deemed as “core clients” to retain relevance for that subset, being more circumspect on others.
“Buyers, while resigned to restrictions in cover, were looking to move away from blanket clauses and obtain language that better reflected their specific portfolios,” he says.
“This made for complex and lengthy negotiations, initially with different stances adopted by reinsurers, before some sense of consensus could be realised.
“A surprise to some was the reduced demand for some sizable retro buyers. This may be explained by perceived veracity of the rhetoric surrounding the pricing dynamics suggested through the summer, when buyers were business planning.”
Gadeke believes that the expectation by reinsurers and brokers that retro rates would again increase (three years in a row) may have been a motivating factor for some of the more established reinsurers to cut risk to maintain or cut their net books.
“The expectation that ceded costs would rise and underlying margins on original business would continue to improve may have been reason enough to take more net,” he says.
“As such, we saw some large buyers either reducing or entirely dropping limit. It served to illustrate those who bought retro as an imperative, versus those who bought discretionally.”
The effect of COVID-19 on renewals was stark. Gadeke notes that early exchanges suggested that reinsurers would require detailed information, not only on quantum, but original policy coverage, loss definitions and hours clauses.
“As it became clearer that the UK was likely to be ground zero for BI losses with the well-publicised skirmishes between some high-profile carriers and mainly the SME sector, this served to increase the requests for loss information and prompted some to push back on suggestion of cover,” he says.
“As with any renewal negotiation, prior year impairment needs to be established or at least estimated which, given the nature of COVID-19 proved to be challenging. Furthermore, a renewed focus on contract language and the elimination of potential for ‘systemic’ losses was fed down from senior executives looking to eliminate parameter risk at all costs.”
All accounts had more protracted negotiations as reinsurers got forensic on terms and conditions. Catastrophe cover with a high preponderance of systemic exposure was scrutinised. Loss-bearing accounts and aggregate/frequency covers became more onerous with reinsurers looking to modify coverage, elevate attachments and mitigate repeat scenarios.
“For some cedants, due to lack of transparency, it was agreed that the potential loss impact would be deferred until 2022, whereas others gave ranges of potential loss,” says Gadeke.
“Many aggregate covers were significantly impaired, and reinsurers worked from that assumption. All retro cover that wasn’t named perils only, went that way.”
Market of choice
Looking at the impact of insurance-linked securities (ILS) capacity on the January 1 renewals, Gadeke says that for ILS (collateralised re) that traded in frequency covers, the early expectation was one of pessimism, with fears of reduced inflows as investor appetite waned after another non-modelled, unexpected loss that wasn’t priced for.
“Investor scrutiny, understanding of loss penetration, and pertinently, trapped collateral were common themes, when talking to the various funds,” he says. “New-new capital looked sparse and many expected existing investors either to ask for redemptions or refuse fresh capital to cover what was trapped.”
As the season progressed, the initial fears began to look unfounded. Many funds had better than expected raises and ‘pleasant surprises’ as investors saw the potential for market dislocation and continued to look for yield in an otherwise stagnant environment.
“Another dynamic could be explained as the larger ILS markets having a smaller pool of cedants to partner with, which allowed the largest players to trade in scale ($50 to $100 million lines),” he says. “This put further pressure on pricing dynamics across a few placements (even aggregate) that was not anticipated. The result was that surplus capital was left looking for a home or returned to investors.
“The cat bond market continued to appear well capitalised, with an increase in issuance, and although sold as an indexed product, it represented an efficient option for minimum priced retro cover.”
Comparing Bermuda to the wider global picture, Gadeke notes that the low barriers to trade and efficiency of platform still make Bermuda a market of choice for many buyers and sellers alike.
“New entrants such as Group Ark Insurance Limited, Conduit, Integral, Vantage and Acacia chose Bermuda to set up with local talent pools, and good distribution channels that provided a great base to grow into an improving environment,” he says.
“Bermuda operates as the largest property cat market in the world, and still dominates the available retro capacity. Collateralised platforms remain the main fulcrum of that sector.
“Cat still dominates the landscape, but other reinsurance lines are growing, with specialty business gaining momentum. Property and casualty excess insurance continue to have good traction with many multi-line insurers.”
Looking ahead to the rest of 2021, Gadeke predicts that while property cat is the Bermuda mainstay, proposed revised collateral provisions for US cedants could see Bermuda become a better home for longer-tail lines.
“Gravitation towards non-cat lines will likely continue as reinsurers look for alternative revenue streams and insulate themselves from over-supply dynamics in the cat space,” he says. “New companies may be a continuing trend through 2021, as private equity investor appetite seems buoyant, and capital is still interested in the space.”
Counter to this, the true impact of COVID-19 will likely take much, if not all, of 2021 to realise and Bermuda will play its part.
“Allied to this is a renewed cognisance that systemic threats need to be calibrated, priced for, or excluded. Badly or non-modelled regions and perils have to be represented within sustained pricing, for acceptable returns to be achieved,” Gadeke says.
“Winter storms Uri and Viola will galvanise this view and it’s not a good start to 2021 for insurers and potentially reinsurers. Pricing doesn’t look like going backwards in the immediate term, even though capacity is obtainable.”