Reinsurers drive premiums through hard market

It is never easy to explain significant insurance premium increases to your clients. Nowadays, the trend among brokers and insurers who are keen to win or retain business is to ‘blame’ their reinsurance partners when costs get out of hand, and they could have a case. In a thought-provoking presentation on ‘the impact of reinsurance on the insurer and customer’, Willie van Graan, Chief Underwriter and Reinsurance Officer at Old Mutual Insure, told attendees at the Insure Talk 30 webinar that a combination of factors was contributing to the present hard market for reinsurance.

Mechanisms for pooling risk

The presentation kicked off with some insurance and reinsurance theory. Insurance was described as a mechanism for the pooling of risks through which the premiums of many pay for the losses of a few. “The pooling of risks faced by many insureds allows for those risk exposures to be spread across populations, regions and time, leading to a reduction in the overall cost of protection, and providing individuals and businesses with the financial protection necessary for making longer term planning and resource allocation decisions,” said Van Graan. It may sound like a mouthful but serves as an eloquent explainer of the economic rationale for insurance. 

Insurers turn to reinsurers to create an additional layer of risk absorption capacity at a lower cost, while handing off risks to global reinsurers allows for some portions of a country’s risk exposure to be distributed to international markets, insulating the domestic financial system from large, internal shocks. So, for example, by taking out reinsurance with multinational reinsurers, South Africa’s traditional primary insurers like Hollard, Old Mutual and Santam, can spread part of the country’s general insurance exposures offshore. FAnews readers no doubt understand reinsurance as “an insurance policy for insurers” but may not be aware of the complexities that exist across insurer / reinsurer operating models. 

Van Graan explained the dynamics using the Aril 2022 KwaZulu-Natal (KZN) floods, which have since been recognised as South Africa’s largest natural catastrophe loss event. “If local insurance companies had to pick up all of the KZN flood related property losses, the event would have been much more dramatic than it was,” he said. “Reinsurance helps us to diversify our risks and to keep the cost of insurance lower for our end user”. Local traditional insurers can use reinsurance to aggregate losses caused by significant loss events such as the KZN floods or the extensive summer hailstorms that often occur in Gauteng, as just two examples. 

Rising frequency and severity of catastrophe events

The total cost to an insurer of its reinsurance programme is influenced by the frequency and severity of natural catastrophe loss events and a range of other domestic and global macroeconomic factors. Price changes are typically ‘felt’ by insurers, insurance brokers and the end customer during the so-called renewal windows when insurers renegotiate their reinsurance covers, with January each year being one of the largest renewal months for the global reinsurance industry. Reinsurers can influence their total risk exposures in various ways, including attachment, coverage and premium or price. As Van Graan explained, there was significant movement in each of these areas during the January 2023 global reinsurance renewal period. This newsletter will consider how each of these factors influences insurance coverage for the end user or policyholder. 

Attachment is a reinsurance term for the limit that a ceding company, or insurer, must pay for the risk on cover on a reinsurance contract; the reinsurer only steps in if the total loss exceeds this limit. Insurers refer to this amount as their retention, or how much of the loss they retain on their balance sheets. In a hard insurance market, as we are experiencing presently, the reinsurer will demand a higher retention. Van Graan explained: In the past a reinsurer may have asked for a R100 million attachment for SA CAT-related property losses, following the 2022 KZN floods they might bump this attachment up to as much as R200-, R300- or even R400 million. Global reinsurers have also started pushing back on the perils they cover. 

For example, local insurers are now finding it more difficult to obtain “all perils” cover through their CAT programmes. “One of the things that the reinsurers focused on during the January 2023 renewal period was what we call grid failure or grid collapse, a systemic risk that reinsurers no longer want to take on in South Africa or elsewhere in the world,” said Van Graan. The typical approach is to withdraw the facility for the pooling of grid failure related risks, thus making it impossible for a local insurer to cover the risk affordably. “It is impossible for us to put a price to a total grid failure because it is not clear what the total exposure will be … we do not know if it will last for one day, 10-days or longer,” he said.

Premiums to the moon

Record natural catastrophe losses are wreaking havoc on the global reinsurance market. “CAT affected perils and regions have experienced significant rate increases [and we have seen] a nearly 30% year-on-year increase in the global CAT rate online over the last five years,” said Van Graan. South African insurers keep a close watch on the European Property CAT rate online index, because SA gets bundled together with the European markets as part of Europe, Middle East and Africa. This rate increased dramatically for 2023, by an average of approximately one third. And thus, insurers and their policyholders face a triple-whammy of attachment point modifications; cover exclusions; and surging rates. 

According to Van Graan, reinsurers have responded to soaring natural catastrophe losses by implementing pricing and structural changes to their cover that are unsupported by technical considerations. In other words, the reinsurers are deviating from the levels of risk and pricing indicated by their catastrophe modelling. This approach causes discrepancies in insurer and reinsurer capital allocations as capital flows to more attractive country markets, leaving shortages in other parts of the world. Higher risk-free rates of return from financial markets are contributing to further capital constraints in the reinsurance sector. As interest rates rise, the risk-free rate of return is bigger causing investors to reconsider the returns they get from investing in insurance or reinsurance companies. 

And profits falling back to earth, or lower

It gets worse. Since 2017, global reinsurers have reported combined ratios of less than 100% in only three years, delivering miniscule profits. And since 2016, “the majority of the reinsurers have not been covering the cost of capital on what their shareholders put in; the shareholders are not getting the effective income that they are expecting from their positions in these companies,” said Van Graan. From a macroeconomic perspective, the 2023 topics of inflation; recession risks; geopolitics; reinsurance capital; the pricing cycle; and ESG are all signalling harder reinsurance markets. “These are all the things that we have to find answers for prior to engaging with reinsurers during our 2023 and 2024 renewals,” he said. 

Overall, hard reinsurance markets are bad news for insurers and end users who face higher retentions; higher catastrophe premiums and higher reinstatement costs in addition to reductions in cover. Solvency regulations also require local insurers are also required to hold enough capital to cover their risk exposures. “If you have a two- or three-fold increase in your retention, it means that you have to hold more capital … and if you cannot get that protection from the reinsurance market, you have to hold that capital yourself,” concluded Van Graan. Hard reinsurance market plus the higher cost of capital means that your clients are unlikely to see respite from higher insurance premiums and cover restrictions any time soon. 

Writer’s thoughts:

I enjoyed the technical aspects of reinsurance presented during the Insure Talk 30 webinar, and hope to have done justice to the topic of hardening global reinsurance markets and their impact on insurers and policyholders. Do you spend much time on the vagaries of global reinsurance markets, or are you happy to explain premium increases with the phrase: because the insurer / reinsurer said so? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts editor@fanews.co.za.

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