The Intelligent Quarterly from the publishers of The Insurance Insider

Spring 2018

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Rapid relief

Marcus Alcock

It was a brutal third quarter for (re)insurers, and there can be little doubt that the facultative reinsurance market has taken a significant proportion of overall insured losses.

While hurricanes Harvey and Irma may have been more meaningful for treaty reinsurers, there can be little doubt that Maria's devastating impact, especially in Puerto Rico, combined with Mexico's two powerful earthquakes in what must surely count as one of the fac heartlands, has hit hard.

As if this were not bad enough, along came the ferocious wildfires in northern California, ripping the heart out of many wineries. Underwriters and brokers alike have been struggling to catch their breath.

There is certainly an expectation among analysts of a significant wider market hardening following these events. Morgan Stanley, which has suggested Q3 industry losses could total more than $100bn, said the significant impact to earnings and industry capital, current low P&C pricing and the potential lock-up of alternative capital could mean double-digit rate increases in property cat reinsurance, and potentially more in the retro market.

Senior management has also supported the need for firming, especially in the property reinsurance market. RenaissanceRe CEO Kevin O'Donnell said he believed there was far more volatility in the reinsurance sector than many appreciated, after a period where there was a dearth of US catastrophe losses.

"Years like 2017 are not outliers," he commented on a recent analyst call, adding that similar aggregate industry losses could be expected every 10 years. "As a sector, we haven't been paid [for] this volatility for too long now," he said.

Indeed, although reinsurers have warned that it is still too soon after hurricanes Harvey, Irma and Maria (HIM) to take a meaningful look at pricing conditions (given that many significant programmes, especially for the fac market, are some way off renewal), there is still an expectation that firming of facultative reinsurance rates could now be around the corner.

For example, Munich Re management board member Hermann Pohlchristoph has argued that "pricing has to do with the whole portfolio. From the sheer size I would be very surprised if we are not to see higher rates across the globe, definitely in property cat, but it goes further".

Swinging a cat
Where fac writers are concerned, there also seems to be little doubt that for cat-affected accounts the rate on line will swing upwards by over 20 percent, and possibly even more where writers are confident of retaining the business.

Indeed, substantial localised property cat rate rises are now on the table for US, Caribbean and Mexican risks, with facultative underwriters suggesting that a number of discussions about price increases have occurred in recent weeks, both on the direct and reinsurance side, as well as talks around tightening terms and conditions.

The feeling seems to be that clients, especially those in heavily affected regions such as the Caribbean, appreciate that the market dynamic is now one where rates can only go one way.

Although areas that haven't been affected as much will no doubt push back on price hikes, one Miami-based fac reinsurer says: "The combination of Lloyd's taking a stand on pricing, in combination with these losses, will probably have an impact on prices in the property fac market."

Hannover Re CEO Ulrich Wallin, speaking on the carrier's Q3 and nine-month earnings call, said he was already seeing evidence of a firming of the reinsurance market on the P&C side "more or less across the board", including on loss-free business.

"[For the market overall], it's still early days, but what we have seen - particularly in the London market on the facultative business - clearly points to increases," he added.

Wallin went on to note that even Asian clients had "some sympathy" for increased pricing. Referencing 2011, when the global market saw an increase in pricing despite a year of mainly Asia Pacific-based losses, Wallin said Asian cedants "expect a similar movement for their markets for the current year".

The Hannover Re CEO told analysts that after 2011 the industry had broadly recorded an overall increase in rates of 7 percent, and that this "should be achievable this time around as well", with loss-affected accounts securing significantly higher increases.

One London-based fac broker says the buying dynamic for cat-affected regions is clear: "I'd say that there's little doubt, especially in loss-affected territories, that what's happened will have a marked impact for many cedants, and we're certainly seeing that in conversations we're having.

"In many ways it's continuing the pattern of recent years, where those insurers that had decided to increase retentions and centralise purchasing have decided to go back to the fac table because they've been hit by losses, though of course this is [a] much wider spread. I guess we'll have a clearer picture over the coming months."

Latin surge
For territories such as Puerto Rico and Mexico the expectation of double-digit rate rises for the property fac market is hardly surprising given their contribution to the overall loss burden, with much of this share likely to be absorbed by fac writers.

As such, comparisons are being made with the 2010 Chilean quake, for which the fac market faced some 50 percent of all claims.

Click to open From a buying perspective, Mexican fac will be of keen interest given the scale of potential earthquake losses - the Chiapas Civil Protection Agency has reported that more than 54,000 homes in the state were damaged, with 98 healthcare facilities and 129 public buildings also hit, as well as roads, highways and bridges.

Fac writers will be hurting given the structure of the Mexican (re)insurance market. The market can be largely split into three distinct areas: Fonden (Fondo Nacional para el Desarrollo Nacional, or the Federal Funds for Natural Disasters), government-owned entities, and private businesses.

The Fonden schemes are run by individual states, which buy programmes to cover the vast majority of uninsured Mexicans and are designed to be the first form of response, covering homes as well as some government-owned infrastructure assets, with a federal umbrella, or "Super Fonden", on top of the states' covers.

The Puebla, Veracruz, Mexico City and Chiapas Fondens are especially likely to be heavily impacted by recent catastrophes, and are disproportionately reinsured in London. The federal government also insures many of its services (for example schools, medical facilities, electricity and water) in the facultative market, with several likely to have substantial losses.

Drilling down into the figures, AIR Worldwide said insured losses from the first temblor, which struck off the coast of the state of Chiapas on 7 September, would be between 14bn pesos and 20bn pesos ($787.6mn-$1.1bn).

However other estimates point to much higher market losses - and hence a bigger hit for fac writers. Indeed, the two major earthquakes which hit the country in September could cost the (re)insurance market up to $5.9bn. Risk modelling agency Evaluación de Riesgos Naturales, which has worked with the Mexican (re)insurance market as well as consulting with construction experts across the region, estimated that insured losses to the market could top out at $4.8bn for the 19 September Puebla quake.

When it comes to fac renewals, although we aren't expecting a really clear picture until the new year, once again it's abundantly clear that writers are pushing hard for a correction in Mexican pricing following years of rate declines, especially after such a poor track record of late.

After an all-too-brief spike in rates following Category 3 Hurricane Odile in 2014, prices have declined at a rate of around 10 percent a year, according to anecdotal evidence. The expected response to this is for direct and facultative rates in Mexico to rise by as much as 40 percent on loss-hit accounts, and by a still-hefty 20 percent on loss-free accounts.

As significant as Mexican losses will be, they are only part of a much wider facultative loss picture. Discussions over Puerto Rican renewals will also be crucial, given that the island has a large pharmaceutical industry, having made a concerted effort to entice companies to locate production facilities there in recent years, with players such as Bayer and Merck among the important manufacturing names. Other significant losses to the fac market will come from hotels, especially those on the waterfront resorts, which are more likely to have major claims.

Casualty creep?
A key question in all of this is the extent to which the wider fac market will see rate increases in the coming weeks and months.

Here there is a great deal of uncertainty, though the word on the fac grapevine seems to be that at the very least some sort of correction will take place. So for local markets in Singapore, for example, the hope is for stabilisation of pricing after years of rating attrition.

And beyond property? Again, much depends on geography. According to Rich Macrane, managing director for facultative at Willis North America, the series of Q3 cats has not turned out to be all that significant for mainland US casualty fac pricing: "I don't think the storms had any impact as the casualty rates were already starting to turn upwards slightly prior to the recent events. This is the case especially in the wheels segment."

However, other writers in the casualty space do detect an impact from HIM, with one suggesting there has been a tightening of terms and reduction in capacity pretty much across the board for his class.

Public pronouncements also support such sentiments. XL Group noted it is already seeing "double-digit" rate rises for short-tail lines, with loss-affected accounts showing higher increases, according to Greg Hendrick, president of property and casualty insurance and reinsurance.

Speaking on an analyst conference call in the wake of the group's third quarter results, Hendrick noted: "For the longer-tail lines, these businesses will also need to deliver improved margins, and we are expecting rate declines in the aggregate to end."

He also suggested that the spread of rating increases would not be limited to particular lines: "[Given] the reality of a challenging rate environment for a prolonged period with increasing return expectations from underwriting capital providers, we believe that all lines will be impacted from a pricing and terms and conditions perspective."

Still, it remains to be seen just how far the casualty fac side of the market will be able to respond meaningfully to such increases, with old wags suggesting we shouldn't hold our breath just yet. And with a great deal of third party capital still sitting on the touchline, no-one is being complacent.

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This article was published as part of issue Winter 2017

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