Hard reinsurance pricing conditions are likely to last longer than in previous market cycles mainly due to persistently high claims activity from the accumulation of medium-sized disaster losses and secondary perils, according to an AM Best report.

As a result, the report indicated that reinsurance prices are likely to remain firm for several more years despite the sector’s strong technical results and high levels of capitalization.

“Unlike previous boom and bust cycles, there are a number of factors—climate trends, an increasingly complex risk environment, and a prolonged period of higher interest rates—that make us believe these improved underwriting margins are likely to last for at least another couple of years if underwriting discipline is maintained,” said AM Best in its report titled “Strong Technical Profits Bolster Momentum for Global Reinsurers.”

Riskier Environment

Keeping the minds of insurance and reinsurance underwriters focused is the fact that claims activity related to natural catastrophes has become less predictable, and smaller events, such as severe convective storms (SCS) and other secondary perils, have become more frequent and expensive.

Indeed, AM Best said, secondary perils, which tend to be less understood and more difficult to model, continue to drive natural catastrophe losses. (Secondary perils include floods, wildfires and severe convective storms. SCS events can comprise tornadic and straight-line winds, as well as large hailstones).

Over the past 30 years, the number of small and medium-sized events – or those below US$5 billion of insured losses – has increased steadily, said AM Best, quoting Swiss Re.

The medium-severity natural disasters are the fastest growing category, “both in terms of frequency of events (on average up 7.5 percent annually over the last 30 years) and insured loss totals (up 7.1 percent),” according to Swiss Re in a separate report published in March 2024.

“Every year since 2017 (except 2019) has generated insured losses in excess of US$100 billion. Despite no major hurricanes in 2023, natural catastrophe losses totaled an estimated US$108 billion,” said the AM Best report, noting that the costliest single event last year was the Turkey and Syria earthquake at US$6.2 billion.

There was also an increase in frequency of US$1 billion-plus severe convective storms, mainly in the U.S., which brought insurance claims of US$64 billion in 2023, according to Swiss Re.

The report explained that one of the main reasons global reinsurers generated excellent technical results in 2023 was the absence of a single major natural catastrophe event in 2023.

The reinsurance sector also has benefited from higher attachment points, lower limits, added exclusions, and narrower contract wording, which means that “most of the working layers’ claims costs are being retained by the primary carriers,” AM Best said. “Rate softening is restricted to the most remote protection layers in the best performing accounts in the U.S. Pricing is still considered attractive and the required discipline to stick to the current terms and conditions seems to be here to stay.”

On the other hand, reinsurance cover for high frequency risks (such as SCS events) has become cost-prohibitive or is severely restricted to the best-performing books, the report said.

Much-Needed Adjustment

The report recalled that the global reinsurance segment until 2017 had been deploying some of its sizable amount of capital to support such high frequency layers.

However, following major losses that year from Hurricanes Harvey, Irma and Maria, when reinsurers’ average combined ratio exceeded 110 and property cat reinsurance rates were at their lowest Rate-On-Line (ROL) index since 2000, (according to Guy Carpenter), the segment began its slow path toward a hardening market. (Combined ratios above 100 indicate an underwriting loss).

Reinsurers started repricing, tightening terms and conditions and moved away from property/catastrophe reinsurance by elevating attachment points and reducing limits. In addition, AM Best said, they expanded their primary and reinsurance operations as well as their casualty books. These efforts included a massive withdrawal of capacity during the January 2023 renewal period.

“A much-needed shift away from high-frequency layers, the adoption of tighter contract wording, and a better-defined scope of cover has repositioned the historical role of reinsurers to focus on providing capital protection rather than stabilizing earnings,” the report explained.

These corrective measures began to bear fruit in 2021 when, for the first time in several years, AM Best’s global reinsurance composite had combined ratios below 100. In 2023, reinsurers saw average combined ratios move below 90 in Europe, the U.S. and Bermuda, and Lloyd’s, AM Best said.

As a result of the segment’s refocus on technical profits, AM Best revised its outlook for the global reinsurance segment from stable to positive in June.

Future Perfect?

Following these corrective measures taken over the past several years (combined with current market and economic conditions), reinsurers’ profit margins will be sustainable over the medium term, although they are unlikely to be maintained at such high levels, said AM Best.

The report suggested that a key factor behind reinsurers’ ongoing underwriting discipline is the lack of new entrants, which has typically occurred in previous hard market cycles when new reinsurers formed to take advantage of hard market conditions. (See related article: What Happened to Reinsurance ‘Class of 2023’? Hard Market Defies Age-Old Patterns.)

“The current hard cycle has not been characterized by capital depletion,” said Carlos Wong-Fupuy, senior director, AM Best, in a statement accompanying the report. “Unlike previous hard cycles and despite the very attractive pricing environment, new company formations have not materialized, particularly in the property catastrophe space. Disappointing results during the previous, prolonged soft market deterred potential new investors.”

AM Best went on to explain that a combination of factors has deterred investors from backing new reinsurers. “Historical underperformance, a riskier environment that is more difficult to model and price, and, most importantly, a new phase of more elevated interest rates, all contribute to a higher risk premium for potential investors looking to fund new ventures,” the report said.

In other words, investors now have higher return expectations because they currently can find higher yields from competing, more flexible investment alternatives that require shorter-term capital commitments.

“Capital has become more nimble and opportunistic, focused either on already well-established and successful rated balance sheets with a proven track record or on short-term insurance-linked securities (ILS) vehicles. Higher interest rates have contributed to this behavior, given the availability of investment alternatives much more attractive on a risk-adjusted basis than in the past.”

Despite above-average catastrophe loss activity during second-quarter of 2024 and a few large losses such as the collapse of the Baltimore Bridge in March, results remain strong and on track for another profitable year, AM Best confirmed.

“After the sharp increases over 2023, the pace of hardening clearly slowed during mid-year renewals, but Guy Carpenter’s Global Property Cat Rate-On-Line Index has already surpassed the hard levels from 2006, which followed hurricanes Katrina, Rita, and Wilma,” the report said.

“The stellar results recorded in 2023 are unlikely to be repeated, and most of the companies’ own targets, although optimistic, are more modest. Performance for the first half of 2024 is very comparable on an annualized basis, providing a comfortable margin for uncertainty.”

Reserving Questions

Outside the natural catastrophe space and following some reserve strengthening actions, AM Best said, there are remaining concerns with the performance of legacy US casualty as well as some life reinsurance books. (See related article: AM Best Puts SCOR’s Credit Ratings Under Review After L&H Reserve Announcement.)

“The big question is how industry-wide these issues might be, as well as how promptly and thoroughly the affected carriers have reacted to correct any issues,” the AM Best reinsurance report said.

AM Best noted, however, that the de-risking and diversifying measures adopted by the global reinsurance segment means that companies are much more resilient than in previous cycles. “The potential adverse development of historical liability books, while impacting performance metrics, is unlikely to have a material effect on risk-based capitalization in a segment characterized by players with very strong Best’s Capital Adequacy Ratio (BCAR) scores or earnings.”

AM Best said that concerns about social inflation in the US liability line “have led to stricter underwriting, client selection, and price adjustments for new business.”

Sophisticated risk management, strong balance sheets, and partnerships with the insurance-linked securities/retrocessional markets are contributing to consistent and more stable results for reinsurers, it continued.

“Although a cautious deployment of capital and a certain level of retrenchment have been necessary to restore profitability, the market position, balance sheet strength, and expertise that the leading players enjoy put them in an ideal position to gradually assume more of the emerging risks that are becoming dominant in a rapidly evolving economy.”