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Insurance is founded on the concept that the premiums of the many pay for the claims of the few. A powerful principle, but the challenge comes when the cost of claims exceeds the total pool of premium. The increasing costs of claims are triggered by a range of factors including natural catastrophes, urban sprawl, interest rates, and claims inflation. For instance, in Australia, the cost of claims has increased by 9.1% since 2013/14, due in part to the 2019/220 bushfire season, where losses totalled $2.3billion.
Each insurer has a limit to how much insurance they can provide – this is known as their capacity. Because there has been a dramatic increase in claims globally, insurers are more cautious about taking on risks and their pricing increases. One way for insurers to offer more capacity is by purchasing reinsurance.
Generally speaking, a hard market is driven by something that is not foreseen by the insurance industry. For example, terrorism has been excluded ever since September 11, just as Infectious Diseases are now being excluded.
I have witnessed similar conditions to the current market while working in London in the years following the 2005 US wind season and while working in Asia following the string of natural catastrophes in 2010-11 which included the devastating Christchurch earthquakes, Queensland, and Thailand floods, and Tōhoku earthquake and tsunami. I wouldn’t classify these as hard markets though. They severely impacted insurers' results and caused significant pricing corrections, however, there was still capacity around for brokers in the following years to complete placements, which is generally not the case in a “hard market”.
The September 11 terrorist attacks triggered what I would classify as a hard market. Before this event, insurance companies hadn’t properly considered the exposure/peril of terrorism, and adequate pricing and aggregate management were not factored into their underwriting. This event depleted global re(insurance) capacity, pushing pricing to levels not seen previously for most products/classes of business. This event also gave birth to a new class of business: Terrorism, which up until this point had been absorbed by property insurers. In the years following, several start-up (re)insurance companies entered the market, particularly in Bermuda; this increase in the supply eventually helped to reduce pricing to pre-event levels over the next decade.
Other than September 11, the 2010 Christchurch Earthquakes caused pricing corrections. This only lasted 18 months and was very much isolated to New Zealand.
I wouldn't say we've hit a hard market yet. A truly hard market is when brokers absolutely cannot place a risk at all. It’s teetering on that for some. Underwriters are told by Head Office “you now only have $10 million of capacity to deploy (typically an insurance company would have hundreds of millions of capacity), so use it wisely”. So that's when I think it would be a hard market - where their hands are almost tied, and everything is a referral to Head Office.
Reinsurance is essentially insurance for Insurers. Insurers purchase reinsurance for the same reason that individuals or businesses purchase insurance - to transfer risk.
Just as a homeowner will look to purchase insurance because they can’t retain the risk of their house burning down; if insurance companies can't retain the risk for a major flood or bushfire, they will look to purchase reinsurance for these exposures.
Reinsurance is a tool used by insurers to manage aggregate exposures and minimise volatility across portfolios via risk transfer. For example, Australia has seen an increased frequency of natural catastrophes such as bushfires, floods, and storms over the past decade, increasing the level of capital insurers need to hold on their balance sheets to continue maintaining coverage for these perils for clients. Transferring some of this risk to reinsurers is often a good solution to manage this.
Reinsurance balances an insurance company’s portfolio, rather than having a major loss that could wipe out a whole year’s premium. Reinsurance protects insurance companies and allows them to keep offering insurance to their clients.
For example, if a client has a policy limit of $10 million, an insurance company may only be able or comfortable in providing $5 million worth of risk capacity to that client. The insurer may look to buy another $5 million of reinsurance, so they can provide $10 million in capacity to that client. In this instance, while only half of the capacity is the insurer’s and the other half is reinsurance capacity, the client will only see $10 million from one insurer, which makes claims management very easy.
The alternative would be to have two or three insurers providing that $10 million in capacity, but any amendments or claims would then ultimately need to be communicated back to two or three insurers. Reinsurance enables you to deal with one insurer who represents your whole policy limit (i.e., $10 million).
Reinsurance pricing will increase in response to losses, but you can also have areas of the market where a shortage of capacity exists, so it’s a supply and demand issue. In markets where insurers have decided not to service certain geographic locations or industries, you have a lack of supply, so the pricing will go up.
It affects it quite a lot. If reinsurance costs are $500,000, that's what insurers need to charge when they provide the insurance to their clients. If the price of reinsurance increases by 20% for a company, then across their entire portfolio they will need to charge an extra 20% in premium to pay for the higher costs. When you hear the term ‘hardening market’ and your rates are going up by 10%, that's because insurance companies themselves have to pay 10% more to continue offering insurance.
For insurance companies, when their cost of reinsurance increases this adversely impacts their expense ratios as their fixed costs remain the same so this, in turn, drives up the premiums they need to charge clients to maintain the same level of coverage.
Claims and capital. The cost of claims and the cost of capital dictate the price increases and decreases of reinsurance. Events such as hurricanes, fires, typhoons, and earthquakes are really driving costs of insurance. These are not the same as isolated events like a fire at a factory - they’re large environmental catastrophes that cost insurance companies, and in turn reinsurance companies, billions of dollars. Unfortunately, it has been another hectic natural catastrophe year to date, which means little chance of reinsurance pricing reprieves landing in the next 12 months.
COVID-19 hasn't helped, and these big losses are suffered by the entire industry. When the insurance and reinsurance markets are losing money, insurers increase their pricing and often deploy less capacity in the insurance products that they offer.
In the current market, rate increases of ~10% are a fantastic result for clients.
An additional factor to bear in mind is that many of these insurers (listed enterprises with shareholders expecting dividends) have been running at a loss for upwards of six years now. Ultimately, it might take a few consecutive years of positive performance before such pricing is passed on to the consumer in the form of lower premiums.
Yes, because the majority of insurance companies will purchase reinsurance for their business globally, known as a 'treaty'. Therefore, even if losses are predominantly affecting the US, it will impact what insurers can do here in the Asia Pacific region.
These days it’s very much a global play for insurers, with direction and strategy dictated from a centralised Head Office, often located offshore. Going back to basics, insurance has always been designed to spread the losses of the few across the many. If you look at an event in isolation and say “I haven’t had a claim for 10 years so I shouldn't pay any additional premium”, that’s great, but the person who had the $100 million loss last year simply can’t pay $100 million in premium the next year. That loss has to be spread between the 50 companies that didn't have a loss that year … so if they do have a loss, they don't pay a $100 million premium in the next year.
Yes, events in the US, Europe, and other countries certainly impact insurance costs in the Asia Pacific. For example, in 2005 and 2017, large losses from the US Hurricane Seasons (Katrina and HIM) impacted the amount of reinsurance capacity available in the market. Most of the major reinsurers have operations all around the world, so this change in supply and demand dynamic resulted in reinsurance prices going up globally which impacted the cost of capital for insurers everywhere, including Asia Pacific.
It’s a worldwide view on investment returns. With interest rates currently at an all-time low, insurance companies aren’t able to make investment returns that have historically been used to offset underwriting losses. Again, it comes back to demand and supply. If the supply of insurance capacity is down, then the pricing goes up.
There are two parts to this question. One is that insurers and reinsurers rely on capital to be able to provide insurance. That capital is provided either through shareholders or private equity and that capital is always deciding where it can get its best return for the dollars committed. If investors can get a good return on investing in insurance, capital will flow freely to insurance companies. If interest rates are 20%, investors can achieve a higher return elsewhere, so they'll take it out of insurance.
The second half of the equation is that insurance companies in turn have their own investment arms. When interest rates are really high, insurance companies are pushed to write a lot of premium to take that cash flow and invest it at higher interest rates. At such times, insurers will have greater risk tolerance and deploy more capacity.
Right now, the big players in the Australian market would have to focus on underwriting profitability as they’re unable to produce investment returns to offset underwriting losses. 'De-risking' is the term they use. This is ultimately driving price hikes. The current climate encourages insurers to reduce the amount of capacity they deploy, so again, supply and demand.
I don't see it happening this year, but I don't think it's too far away, to be honest.
If there are no major natural catastrophes, and there is some relief from COVID-19, investors will start to see two or three years of profitability from their insurance investments. With interest rates where they are, investors globally will see insurance as a way to secure a relatively high return on investment. As an investor in a depressed economy, if I’m able to secure 10% by investing in insurance stocks, that's fantastic, where else would I get that type of return? Give it another year or two of that type of return and you’ll start to see capacity come back into the market. Some insurance companies have short memories, they'll start to come back and they won’t be so selective and aggressive.
Most insurers have seen strong positive compound rate change since 2017, however, the market still isn’t back to pre-2012 pricing levels which gives you an idea of how much rate left the market during the softer underwriting years of 2012-2017. I think the pricing is going to remain pretty consistent for the next 1-2 years as most insurance portfolios are only just getting back to or nearing 100% of technical adequacies so underwriting discipline will continue.
The clients who will fair best in the coming years will be those who invest in their risk management, prioritise quality risk data and up-to-date information, and engage with proactive brokers presenting detailed submissions to insurers months before inception.
These market conditions are fluid, and we are committed to keeping you updated and informed with relevant and practical insights as the situation evolves.
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