Insurers in the London, Europe and Bermuda markets writing catastrophe-exposed business take a different approach to retention of risk at the 1-in-100-year return level in comparison to the 1-in-250-year level, according to report published by A.M. Best.

At the lower return period, retention has increased more steeply when pricing is favorable. In contrast, the sensitivity to price of retained 1-in-250-year risk appears minimal — a reflection of capital allocation decisions, such as the management of Solvency II capital requirements, said the report titled “Catastrophe Exposure Grows; Alternative Capital Used Selectively.”

As part of its tracking of industry trends, A.M. Best analyzed probable maximum loss data from 25 of the largest of its rated re/insurers, which wrote catastrophe exposed business in the London, Europe and Bermuda markets between 2012 and 2015.

The report noted that the sample group of companies’ gross probable maximum loss (PML) growth fell short of estimates of the increase in industry-wide exposure between 2012 and 2015 at both risk levels, “most likely due to the expansion of alternative capital insurance vehicles, together with reinsurance program consolidation and variations in the propensity of other cedents to reinsure into the insurers that comprise A.M. Best’s sample.”

The calculation of indices of PMLs, both net and gross of insurance, for 1-in-100- and 1-in-250-year risk for the sample insurers indicate they were “retaining considerably more catastrophe risk by the end of the period” than in 2012, said Anthony Silverman, senior financial analyst, A.M. Best.

However, he noted that the increase in retained risk, whether driven by price or consolidation of reinsurance programs, has been more a feature of 1-in-100-year risk than of 1-in-250 year risk.

“Growth in retained 1-in-100-year risk broadly matched the increase in industry-wide exposure over the period of the data,” Silverman noted.

The reported explained that the sample group of companies increased retained 1-in-100 year risk in 2013 when pricing was favorable and as net PML figures grew at a faster pace than gross PMLs. However, in 2014 and 2015, net PMLs increased at a slower rate than gross PMLs as prices deteriorated, said the report, noting that in contrast, the sensitivity to price of retained 1-in-250-year risk appears minimal.

The relative loss of exposure will most likely have been due to the expansion of alternative capital insurance vehicles, together with reinsurance program consolidation and variations in the propensity of other cedents to reinsure into the sample,” the ratings agency said.

“On a net basis, increases in the sample’s PMLs at the 1-in-100-year return period kept pace with industry exposure growth,” the report said.

By contrast, growth in net 1-in-250 PMLs lagged behind industry-wide estimates. “In A.M. Best’s opinion, this suggests that the use of capacity from alternative capital by traditional re/insurance market participants has been selective, in respect of both the layers of risk ceded and price, with re/insurers more likely to offload 1-in-250-year risk to the capital markets, rather than 1-in-100-year risk.”

The movements in PMLs discussed in the A.M. Best report were driven “by a combination of pricing, reinsurance purchasing trends, growth in underlying industry-wide catastrophe exposure and regulatory constraints.”

Alternative Capital

The influence of alternative capital and the development of “insurance as an asset class” for the wider capital markets has been primarily a story about catastrophe reinsurance and retrocession, said Silverman.

“Wider capital market participation in insurance often is discussed in terms associated with technology products, leading to expectations of disruption, transformation and very rapid timescales for change,” he added. “However, there are reasons to expect the influence of alternative capital will have its own limits.”

The report predicted that despite the scale of wider capital markets, at least some part of alternative capital in the catastrophe reinsurance market will withdraw in response to large losses.

“For example, the market has developed to include participants with varying degrees of commitment. Providers of collateralized reinsurance would likely find pledged collateral frozen, and those who have invested in part as a response to low returns elsewhere may be uncomfortable with negative returns,” the report went on to say.

Source: A.M. Best