Reinsurance buyers seeking a ‘break-glass’ strategy: Howden Re’s Flandro

Reinsurance rates are falling despite an elevated risk environment, giving buyers an opportunity to build protection just as reinsurers edge closer to the point where further softening could begin to affect economic value creation.

Key points:
Buyers planning for volatility
Further rate falls affect economic value
Underwriting discipline back in focus

Reinsurance buyers can use today’s abundant capacity to build a “break-glass” strategy – having protection options ready if conditions suddenly turn – says Howden Re’s David Flandro, as falling rates collide with a more volatile risk environment. 

At the same time, reinsurers are approaching another threshold. The average economic value-added spread, used to measure a company’s return generated in excess of its cost of capital, is now close to zero, raising the prospect that further rate reductions could push some in the sector into negative economic value creation.

“If pricing goes down and nothing else changes, then in theory, economic value-added spread of the sector will go negative.”

“Rates are falling really quickly at the same time that the world seems to be getting riskier,” Flandro, head of industry analysis and strategic advisory at Howden Re, told Monte Carlo Today.

Property catastrophe pricing has fallen sharply from its 2023 peak as retained earnings and fresh capital have increased capacity. Flandro said the resulting conditions give buyers room to rethink how much protection they purchase and how they prepare for a sudden reversal.

“How do I, the buyer, optimise my reinsurance purchase, and what is my break-the-glass strategy in the event something goes sideways?” he said.

Those contingencies could sit across reinsurance purchasing, capital management and underwriting strategy. Flandro also believes AI could eventually make more standardised reinsurance risks tradable, helping create a secondary market that has so far proved difficult to establish.

“What we learn from history is that the widely accepted assumptions that everybody has are right until they’re suddenly wrong,” Flandro said.

He pointed to previous turns in the cycle, including 2022, when inflation, sharply higher interest rates, bond-market losses and Hurricane Ian combined to transform conditions rapidly. Howden’s risk-adjusted property catastrophe rate-on-line index rose 37% at 1/1/23.

Economics ‘close to even’

Three years after that hardening, the economics have shifted considerably.

Reinsurer economic value creation is now “very close to even”, Flandro said, leaving little room for another material fall in pricing if other factors remain unchanged.

Flandro favours economic value-added as a measure of whether reinsurers are generating sufficient returns after taking account of their cost of capital. It compares return on invested capital with the weighted average cost of capital and, Flandro says, correlates most closely with carrier valuation metrics

“The economic profitability of the reinsurance sector is close to even at the moment.” he said.

“If pricing falls further and nothing else changes, then in theory, the average reinsurer’s economic value-added spread will go negative.”

That is different from saying reinsurers will become unprofitable, he hastened to add. Companies might still produce accounting profits and meet internal performance targets while failing to generate a sufficient return relative to the capital supporting the business.

Howden Re has previously said that another comparable leg down in pricing could put parts of the industry below their cost of capital by 2027.

Flandro said reinsurers are increasingly conscious of how quickly they could return to the economics that prevailed before the 2023 reset.

“If current trends continue, some carriers will be back to where they were before 2022; we know that in that scenario, things can become economically unprofitable,” he said.

The pricing tailwind is gone

 “It pays to challenge the prevailing wisdom.”The change in conditions will also make underwriting decisions more visible.

“There is no pricing tailwind, so forward underwriting profitability will be based on actions taken now,” Flandro said.

He described this point in the cycle as the moment when underwriters “show their mettle”, with performance beginning to separate those that maintained discipline from those that chased business aggressively.

“We will be able to sift quite clearly, in terms of different performance metrics, the wheat from the chaff,” he said.

Casualty provides a warning from the previous soft cycle. Some insurers and reinsurers that wrote too aggressively when pricing was inadequate are still dealing with the consequences.

The difficulty now is balancing underwriting discipline with pressure to maintain growth.

“I used to be an equity analyst,” Flandro said. “There’s a lot of pressure on reinsurers to grow top line, even as the cycle softens. But a good investor will understand that growth must be profitable.”

This means growth is still desirable where returns remain attractive or where additional business strengthens an important client relationship. But the easy support provided by rising rates has gone.

AI making reinsurance tradable

A separate change could alter how some of that risk is ultimately placed.

Flandro believes AI could help create a functioning secondary market for reinsurance risk, an idea the industry has explored repeatedly without achieving widespread adoption.

The obstacle has always been complexity. Reinsurance contracts differ by structure, attachment point, exposure and modelling assumptions, making them difficult to standardise and trade in the way equities or bonds can be traded.

Flandro believes AI could lower some of those barriers.

“Could AI be part of the mechanism here to make secondary trading more viable? I think it will,” he said.

He does not expect technology to remove the need for brokers or for negotiations around complex programmes. Bespoke risks will continue to require experienced people and established relationships.

More standardised risks could develop differently.

“You’ll have something more akin to the equities market or the DCM markets, where there will be plain vanilla risks that can be quickly intermediated using AI at a lower cost,” he said.

“I think that is coming. I don’t know exactly when or how.”

AI is already beginning to affect other parts of the broking and underwriting process. Flandro expects administrative costs to fall and modelling and analytics to change significantly as companies become able to build and update models faster.

“I think modelling and analytics are going to change markedly,” he said.

For the immediate renewal, however, pricing remains the more pressing issue.

Buyers have more options and more available capital. Reinsurers have less economic margin for error. Both are making decisions against a backdrop that could change quickly before 1/1.

Flandro’s advice is simple: “It pays to challenge the prevailing wisdom.”

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