INTERVIEW: TIM EDWARDS & DAVID FLANDRO, HOWDEN TIGER
Reinsurers could reap the rewards of ‘goldilocks’ effect
As hard market conditions and atmospheric weather patterns change, reinsurers could be about to enjoy a very favourable environment.
Reinsurers could be about to benefit from a “goldilocks” period as market conditions and levels of catastrophe losses combine in a way that that may result in favourable underwriting returns enduring beyond the upcoming 1/1 renewal.
That is the opinion of Tim Edwards, EMEA head of catastrophe analytics, and David Flandro, head of strategic advisory, at Howden Tiger, who base their opinion partly on the findings of a report by the broker titled “Today’s natural catastrophe portfolio: a balancing act”, published in September.
Flandro explained that this unusual convergence of positive scenarios for reinsurers comes in two parts. First, as evidenced by Howden’s “The Great Realignment” report, reinsurance rates are at historic highs thanks to an enduring hard market driven by several years of nat cat loss volatility and, subsequently, an excess level of demand for reinsurance relative to its supply, with no sign of this imbalance abating.
At the same time, using insight from a historical nat cat loss analysis apportioning losses between cedants and reinsurers, Edwards notes that cedants are now retaining significantly more nat cat losses—64 percent of historical losses back to 2001 on an “as-if” basis, compared to 54 percent a year ago. Reinsurers’ earnings volatility should therefore improve, although investors have noted that they need to prove this over the next few years, not just in the short term.
Weather patterns
Earlier this year, the El Niño Southern Oscillation (ENSO) cycle, which influences global atmospheric weather patterns, switched away from a multi-year La Niña cycle, associated with more severe nat cat losses, to an El Niño phase, typically associated with lower loss activity in key nat cat regions.
Historically, land-falling hurricanes in the continental US have been 1.75 times more frequent in a La Niña season compared to an El Niño phase. Similarly, in Australia 15 of 22 major flood and cyclone nat cat events have occurred during the positive phase of the Pacific Oscillation Index, a La Niña event.
Edwards and Flandro describe this as a “historic moment for the reinsurance marketplace” as they stress the challenges reinsurers have endured until very recently.
“The elevated cost of capital means it is more expensive to enter the industry.”
David Flandro, Howden Tiger
“This favourable period comes on the back of a period of very high loss volatility compounded with other headwinds in the form of increased inflation, increased interest rates elevating capital costs and a lack of outwards risk transfer capacity.
“This has clearly shifted to what are arguably the most favourable tailwinds that the reinsurance market has ever seen,” Edwards says.
“We have a very strong reinsurance property-catastrophe rating environment, certainly the most favourable since the 1990s. We are currently in the El Niño phase of the cycle, the overall net effect of which, empirically speaking, should portend a lower level of cumulative losses overall,” adds Flandro.
“This appears to have been the case for reinsurers so far in 2023.”
If Edwards and Flandro are correct, this could mean that over the medium term the reinsurance sector looks more attractive to potential investors—more so than in recent years. Flandro notes however that “the current level of new capital influx still lags that of previous hard market cycles in 2001/2 and 2005/6”.
“We are only just getting back to 2021 levels of dedicated capital,” he says, implying again that the sector needs to sustain the current levels of underwriting returns over a multi-year period.
Flandro explains that there was a 17 percent reduction in dedicated reinsurance capital last year as a result of underwriting and investment losses, which the industry is only now restoring. For context, he notes, in 2016/17 the ratio of total dedicated capital to premium was around 130 percent. Now, it is closer to 100 percent.
“The combined effects of increased interest rates, macroeconomic instability, and the recent period of heightened nat cat losses continue to give some investors pause. Equally, the elevated cost of capital means it is more expensive to enter the industry and to underwrite business.”
“It is important to look at climate change as part of an overall picture.”
Tim Edwards, Howden Tiger
The impact of climate change
Such analysis around the influence of the various headwinds and tailwinds must also consider the effect of climate change on reinsurance portfolios. Edwards says Howden Tiger is very mindful of this, but is keen to put it into context.
“Climate change is a real phenomenon; the scientific consensus is that temperature-impacted perils are likely only to get more extreme and severe. But the impact of climate change can be small compared to the effects of exposure growth and inflation over time—as indicated by Howden Tiger’s November 2022 article on nat cat loss trends and catastrophe models.
“It is important to look at climate change as part of an overall picture. Bizarrely, some perils are being mitigated through increased temperature. It is a very complex situation. But the market is arguably already factoring in the current climate conditions over and above historical levels.
“The challenge is how much further ahead do they think to attune their businesses,” he says.
Edwards believes that the nat cat volatility experienced from 2017 to 2022 is not necessarily illustrative of a longer-term trend, which is why head- and tailwind impacts on nat cat portfolios over a five-year average period were examined.
“Yes, there has been an elevated level of major nat cat losses in recent years but there could be more benign periods ahead. From Hurricane Wilma in 2005 to the 2017 hurricane season there were no major Florida landfalling hurricanes; this immediately preceded a run of very bad hurricane-affected years,” he says.
“We should expect that sort of volatility from year to year but, as our report shows, we also need to uncouple those various effects and help people understand the true level of underlying risk and how this compares in time.”
Boiling all this down to the current renewals, Edwards and Flandro expect this renewal season to be more orderly than a year ago. But they are also clear that there will be some local factors at play, which could impact specific treaties.
Tim Edwards is EMEA head of catastrophe analytics at Howden Tiger. He can be contacted at: tim.edwards@howdengrp.com
David Flandro is head of strategic advisory at Howden Tiger. He can be contacted at: david.flandro@howdengrp.com
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