Hopes were high going into January 2021 renewals that rate increases would finally materialise, allowing reinsurers to cover their cost of capital and start generating decent returns, but those who had such expectations were to be disappointed. Glenn Clinton, managing director of ILS Capital, explains why.

The expectations for rates leading up to the January 1 renewal period were bullish—and they needed to be. Barring a few notable standouts, reinsurer returns in the past five years have been nothing to crow about.

Stock valuations are generally weak and social inflation is bringing the prospect of real inflation back to life. Coupled with a big black cloud of uncertainty from COVID-19, this surely meant that besides pumping incurred but not reported (IBNR) back up, we had to do something.

Talk of increases in the 15 to 20 percent range for North American cat business was common, and that was what we told our investors we expected. We also hoped that the seemingly endless drag from Hurricane Irma and Typhoon Jebi would help pull international rates up close to a mid-single digit increase.

Yet again, it didn’t happen.

According to the Guy Carpenter Global Catastrophe Rate on Line (ROL) index, the actual rate increase seen at January 1, 2021 was a paltry 4.5 percent. That is a smaller increase than at January 1, 2020, which came after a relatively benign 2019. At the time of writing the index was sitting right at 200 (199.9) which means that in 20 of the last 30 years, reinsurers have enjoyed more rate than we get right now.

Why it happened

One could excuse a frustrated C-suite executive asking: “How can this be?”

Historically, after significant loss events like Hurricane Andrew, the World Trade Center attacks, hurricanes Katrina, Rita, and Wilma and the Tohuku earthquake, reinsurers drove the market. If earnings were nil, or capital had taken a hit, it was a relatively straightforward premise that prices were going up. And they did, sometimes by a lot.

In December 1992, I passed one of the early renewal proposals across the desk to my boss asking if the 100 percent rate increase on the Tony Taylor-led slip could possibly be real. Without looking up he simply said “Just get the line down quickly!”.

Since 2017, if you take the 10 most expensive (Property Claims Service) PCS events and add the four Japanese typhoons it totals $160 billion, which is fully 27 percent of total global 2020 reinsurer capital of $590 billion (according to Aon). For 2020, the PCS loss total for US insured losses currently sits at $64.5 billion, making it the second worst year in history behind 2017.

“Do we hold those with underwriting authority accountable for the results of their decisions?”

Reinsurers haven’t borne all this pain, of course, but my point is these have been very difficult years, and the cumulative global cat ROL index increase of 16.2 percent in the 4 renewals since 2017 is simply not good enough. It largely explains why we are not close to covering our 7 to 8 percent cost of capital.

I believe the minimal property reinsurance rate increase seen at January 1 had very little to do with lead reinsurers driving pricing. Gone are the days where established London leads such as Taylor, RJ Kiln, or Bermudian powerhouses such as PartnerRe, XL, RenaissanceRe and IPC Re drove pricing with $50 million lead lines and non-negotiable conditions. Today a broad consensus is established, much like a coalition government, often without an experienced and respected lead signature on the slip.

The increase was certainly not driven by the new capital that came in the class of 2020. Half the approximately $20 billion in new money is ‘traditional’ reinsurance capital and $10 billion/$590 billion is a 1.7 percent increase, when some see COVID-19 loss estimates in the $250 to $500 billion range. This amount of new money could never move the needle.

Insurers are flush with cash

It’s my opinion that two things drove the cat index at January 1.

The first is that reinsurers got more rate at 1.1 because insurers around the world have been taking rate for years. Their market is hard and they’re flush with cash.

In February 2021 Guy Carpenter reported: “Global commercial insurance prices rose 22 percent in the fourth quarter of 2020, the 13th consecutive quarter of price increases. The fourth quarter rise in pricing was the largest year-over-year increase in the Marsh Global Insurance Market Index since its inception in 2012.”

Although admittedly the index is skewed by large account commercial business, price increases have been seen across small and mid-market accounts as well. Insurers’ short-term profitability should also improve as coverage restrictions for riot and civil commotion, business interruption (BI) without physical damage and tighter communicable disease exclusions take hold.

There can be little doubt that our clients enjoy far better market conditions than we do at present, and this must surely be the first time in history when the direct insurance industry can be credited with leading any part of a reinsurance market pricing uptick. They’ve been in the pricing doldrums for decades and are now enjoying the best conditions many have ever seen.

Pandemic effects

The second driver of the index has to do with the dynamics of the COVID-19 losses being experienced in both casualty and property.

Only now with the Financial Conduct Authority’s decision on BI losses is there any certainty of the property loss position in the UK. The US will dwell in uncertainty for years on the property quantum, and it’s a very similar situation with casualty. No-one really knows where the losses will settle, proven by insurer estimates for BI losses which vary wildly, even in the most disciplined underwriting operations.

Stephen Catlin said in an interview in January that “the COVID-19 can will be kicked down the road for years and that means the road will get longer and the can will get heavier”. Anyone with a sense of history knows he is absolutely correct and that the magnitude of the eventual COVID-19 losses are being greatly understated at present.

The EML acronym will apply here, although I suspect one can replace “estimated maximum loss” with “eventually much larger”. At some stage, reinsurance pricing will need to reflect this understatement, but we’ve not begun that journey with any great gusto.

Paul Simons, chief executive officer of reinsurance at XL Bermuda and head of property, global markets, reinsurance at AXA XL, wrote a thoughtful piece in December about the psychology of rate change. His basic premise was that for all the:

1. Quantitative improvements to underwriting in the past decade (bespoke business and pricing models with vendor model blending);
2. Far greater accuracy and clarity in the data we get from clients; and
3. Undoubted increase in the quality of new entrants to actuarial and underwriting positions,

there is still an inexplicable reticence among some less experienced underwriters to push for rate. We must do more to understand the psychology of forcing through rate increases because, despite pressure from C-suites and line managers, the evidence is clear that they baulk under pushback from brokers and buyers.

What next?

This leads to the following questions:

a. Is it only battle-hardened grey heads bearing the indelible scars of large market losses who can effectively fight for better terms and conditions?

b. Do we create environments in which people feel free and can be at their natural best to do what we need them to do?

c. Are underwriting manuals too rigid? Do they permit people to see what they want or rather see the things that prevent them from getting what they want?

d. Are clear lines drawn in the sand between quotes and firm orders, and are these lines consistent enough to encourage walk-away behaviour?

e. Without a link between results, compensation and tenure, there is no clear responsibility for the numbers. Someone has to own them, and the closer to they are to the decision-maker the better they get. Do we hold those with underwriting authority accountable for the results of their decisions?

f. Is it realistic to entrust 30-somethings with writing retrocessional business?

The answer probably lies in an honest examination of these variables. There is no substitute for experience, but neither is there a substitute for rate.

“Ask yourself if you can say what the broker has just said without laughing.”

You can never underwrite your way clear of adverse moral hazard, and the social inflation creeping into all lines is an increasing concern, but it is possible to get a handle on physical hazard, and the commercial considerations attached to each piece of business.

Thirty years ago I cut out an article from a market periodical that I’ve had on my desk ever since.

Titled “Some practical advice”, a senior London underwriter set out some non-negotiables for success in underwriting prior to a renewal season in the late 1980s. It is timeless advice.

1. Do not underwrite by formula—underlying portfolios are far are too complex, a rigid approach will not serve you.
2. Never base a decision on a bunch of numbers, particularly if they come in the form of a questionnaire.
3. See the “whites of the cedant’s eyes”. Understand the underlying business, the cedant’s philosophy and how he sees himself within his market.
4. Now go back to the data and see if it makes sense.
5. Refuse to accept lame excuses and lack of information—this is incompetence and concealment.
6. If you sell cheap reinsurance, be prepared for it to come back to bite you. You can take the rate up by that much now.
7. Ask yourself if you can say what the broker has just said without laughing.

I’ll add one of my own: 8. Never forget, PML —probable maximum loss—also stands for probably much larger, and your capital is the backstop for what flows down the hill.