A combination of hurricanes, earthquakes and wildfires cost the insurance industry over $140 billion in 2017, the highest inflation adjusted global insured loss on record.
Yet the much anticipated market correction failed to materialise and the modest rate increases seen in January have since diminished during subsequent renewals.
The Florida property-catastrophe renewal on 1 June, which coincides with the start of the annual US hurricane season, resulted in only negligible increases. Pricing for Florida property-catastrophe business increased just 1.2 per cent at the June renewal and remains 40 per cent down on 2012 levels.
JLT Re’s Risk-Adjusted Florida Property-Catastrophe Rate-on-Line (ROL) Index has risen just 1.2 per cent this year.
The influx of alternative capital into the reinsurance market since Hurricanes Harvey, Irma and Maria is key to understanding the market reaction, which may at first seem illogical.
Alternative capital providers experienced significant losses in 2017; however, they were quick to reload and return to the market with increased capacity.
Some $7 billion of new capital was raised in the final four months of 2017, while capital has increased by a further $10 billion due to earnings and unrealised gains, in addition to investment during the first half of 2018.
JLT Re estimates that dedicated reinsurance capital is back at record levels, in large part due to the increase in alternative capital, which now accounts for 23 per cent of dedicated reinsurance capital compared with just 7 per cent in 2005.
As a result, dedicated reinsurance capital has increased at a faster rate than premiums, putting rates under additional pressure.
In 2010, global reinsurance premiums were $229 billion, rising to $261 billion in 2017, while capital increased from $250 billion to $340 billion.
The influence of alternative capital was apparent at the recent Florida renewal.
Not deterred by last year’s catastrophes, insurance-linked securities (ILS) markets were vigorously looking to deploy capital at the renewal in June and competed heavily with traditional reinsurers.
“Dedicated reinsurance sector capital remains strong, despite record catastrophe losses in 2017, and alternative capital has shown itself to be committed to insurance risk.
“It’s now obvious that the means through which the sector raises capital at the margin have completely changed over the past decade, with huge implications for property-catastrophe reinsurance pricing and underwriting in particular,” says David Flandro, Global Head of Analytics at JLT Re.
Although insurance and reinsurance rates have not increased as steeply as underwriters would have liked, the record losses in 2017 have had an impact.
Underwriting discipline has returned to the market and insurers are now much more focused on addressing underperforming parts of the market, according to Paul Knowles, CEO of JLT Specialty.
“As a result of catastrophe losses, as well as underlying attritional losses, we see greater discipline in the market and rates have held in 2018.
Quality risks continue to attract competition, although underwriters are quick to seize any opportunity to underwrite,” he says.
This combination of underwriting discipline and ample capacity makes for interesting times ahead, explains Knowles.
“If we see average or above average catastrophe losses this year, I would expect the momentum in market discipline seen in the first half of 2018 to continue.
However, if we see a benign year for losses, the market could slip back and competition could well intensify,” says Knowles.
Unsurprisingly, all eyes are now firmly on this year’s hurricane season. However, catastrophe losses in the first half of 2018 have been relatively light and initial forecasts for an above average hurricane season have been revised downwards because of unseasonably cold waters in the Atlantic.
Even if large catastrophes do materialise in the second half of 2018, the reinsurance market has shown itself to be in a strong position to deal with any potential losses.
Flandro believes that an unexpected or exceptionally large loss is now required to turn the market. A $250 billion industry loss is not beyond the realm of possibility, while several years of record losses would alter market dynamics.
A change in investment yield that leads to a significant reduction in alternative capital could also have a similar impact, although no such change is on the horizon, he notes.
The nature of the catastrophe
One of the factors shaping the market’s response to last year’s record losses was the nature of the events.
While each catastrophe was significant – Irma was one of the most long-lasting intense storms ever recorded while Harvey set a record for the most rainfall ever from a tropical cyclone in the continental US – they were within expectations while losses were largely in line with catastrophe models.
“2017 was a significant year by any measure and, at over $140 billion, last year was the largest ever in inflation adjusted terms in modern times.
“However, this is more a reflection of increased exposure, rather than it is indicative of a change in underlying hurricane or earthquake risk.
“Recent decades have witnessed huge growth in insured assets and economic activity in catastrophe exposure areas,” says Flandro.
The growth in insured catastrophe risk has seen losses increase almost exponentially over the past 40 years (see chart below).
The 2017 global loss was almost ten times the inflation adjusted loss of $16 billion recorded in 1978, a record year for catastrophes at that time.
Economic development around the world, in particular with increased insurable risk and insurance penetration in Asia Pacific, is likely see insured catastrophe exposures and losses continue to rise, predicts Flandro.
“Asia is perhaps the greatest area of exposure and has the biggest likelihood to surprise. Perils like the US hurricanes and the Mexico earthquake are fairly well understood and modelled, but the same cannot currently be said for Vietnamese earthquake or Chinese cyclone risk,” he says.
Significant growth in catastrophe exposed risk could, however, provide a home for alternative capital, which is looking for new perils and territories to invest in.
Similarly, excess capital in the wider insurance market could support innovation in areas such as cyber, supply chain risk and protecting intangible assets like reputation and IP.
“Alternative capital has shown itself resilient but, the question now is, how can it be made more relevant? If large losses were to erode dedicated reinsurance capital, alternative capital might become even more important, while there are also new risk areas that could utilise the current surplus capital in the market,” says Knowles.