Wake-up call: higher cat losses a warning, say reinsurance execs in 2016 look back

The higher levels of catastrophe losses in 2016 could represent something of a wake-up call for the re/insurance industry after a number of years of benign loss activity – especially against a backdrop of a continued soft market in most lines of business, according to a number of senior executives interviewed by Intelligent Insurer.

As 2016 drew to a close, Intelligent Insurer asked a number of re/insurance executives for their opinions on the most important developments in the re/insurance industry in 2016. A significant number cited the high levels of cat losses and the effect these may have on an industry struggling for profitability already thanks to soft market conditions.

Jon Sullivan, portfolio director, short tail treaty, Brit, said that the losses from Hurricane Matthew, though not as large as some had predicted, reminded the industry how unusual the US landfall (and particularly Florida) frequency has been recently and how results might look once landfall normalises.

“In the latter stages the ‘hook storm track’, that didn’t materialise, running Matthew back around, through Florida again and onwards into the Gulf, could truly have been a monster loss, testing coverage, capital and wordings,” Sullivan said.

He added that the Fort McMurray wildfire in Alberta, Canada, in May was also an unusual loss that fell unevenly among reinsurers. “A peril that may have been priced for in lower layers reached levels previously considered as earthquake only. The total industry loss at or around $3 to $5 billion wasn’t substantial but this was a loss that hadn’t been budgeted for in companies’ cat margins, which is the important point,” he said.

“Low-level buying meant most of the loss was passed on to reinsurers who needed to recalibrate pricing on higher layers with additional allocated loss cost for a new peril exposure with varying degrees of success, meaning little pricing upside. Fort McMurray was joined in the first half of 2016 by earthquakes in Ecuador, Taiwan and Kumamoto in Japan, plus cyclone Winston—all relatively small losses but which eroded margins and caused concern ahead of the US hurricane season.”

Jeremy Brazil, director of underwriting, Markel International, added that in the scheme of things it was again a pretty benign year in terms of cat activity with no major hurricane losses. But he also noted that if Hurricane Matthew in September/October had tracked 30 miles to the west, it would have been a different story, with much higher material losses.

But he identified deeper problems in the industry that a lack of very big cat losses continues to mask.

“There are so many hard-to-read uncertainties around at the moment that the world seems as insecure as it did in 2007/2008. And in many ways it’s worse for insurers. 2016 was a relatively cat-free year in which combined ratio performance were still in the 90s. That was after a period when people have been releasing reserves and when the interest rate environment continued to put pressure on investment returns,” Brazil said.

“If all the stars line up badly, the combination of worsening loss ratios, reserve pressure and weak investment returns could be very difficult for the industry.”

On a similar note, Brandan Holmes, senior analyst at Moody’s Insurance Group, added that continued price declines and persistent low interest rates are set to drive normalized profitability below cost of capital in 2017 – something that will become a problem for the industry.

“Reinsurers' profitability continued its steady downward trend, driven by reinsurance prices that continued falling for the fourth consecutive year, and interest rates that remained at historically low levels,” he said.

“Return on equity for our cohort of rated reinsurers decreased from 12 percent in 2013 to 8.4 percent through Q3 2016, still slightly above reinsures’ cost of capital, which is generally in the 7 percent to 8 percent range. However, the reinsurers benefitted from below-expected major losses over that time period – normalizing for expected major losses, we estimate that most reinsurers’ ROE’s would be between 2 percent and 5 percent lower and therefore below the cost of capital threshold.”

Analysts at S&P Global Ratings also expressed concerned over the continued soft market and reinsurers’ profitability but stressed that potential reserve inadequacies represent a bigger concern than a large single catastrophe loss.

Johannes Bender, Taoufik Gharib and David Masters, speaking as one, said that a large single natural catastrophe event would likely not significantly erode the current reinsurance excess capacity. Even if Hurricane Matthew (that hit Haiti, the Dominican Republic, Cuba, Bahamas and the US in September/October) had been a much more severe loss event (for example, with a return period of 100 years) than Hurricane Katrina, the current AAA capital position would have been maintained by the sector, in aggregate, in 2016, they said.

“A more tangible concern for capital adequacy could occur from major reserve strengthening measures. We don’t yet see evidence of reserve inadequacy, but we recognise that a potential widespread increase in claims—affecting multiple lines of business across various jurisdictions—could trigger capital volatility and, ultimately, significant pricing adjustments. This scenario would, in our view, most likely arise from elevated claims inflation, but it could also affect long-tail lines of business if an asbestos-type event were to occur,” they said.

In total senior executives from companies including Swiss Re, Argo, AM Best, Moody’s Markel, Advent, Barbican, Brit, Ed, Fitch, S&P Global Ratings and Willis Re participated in the examination of 2016. To read the full transcript of their thoughts and comments, please click  here.