Inflation driving increased demand for catastrophe reinsurance in run-up to 1.1

Inflation has emerged as the dominant theme influencing the upcoming 1 January property renewals as higher exposures and the prospect of increased claims costs drive demand for limit, with the industry’s reinsurance intermediaries forecasting that the issue will shape reinsurers’ view of risk.

There is a consensus that inflation will be the number one topic at renewal, driving increased demand for catastrophe reinsurance at a time of tightening supply following a number of exits or significant pullbacks from property cat, including Axis Capital, Markel, Axa XL, TransRe and Scor.

While inflation related to property insurance is up to varying degrees in all regions, peak peril risk in the US is seeing some of the highest impacts. Aon said in its latest market outlook report that an estimated $5bn in additional reinsurance limit was sought by insurers at the June and July 2022 renewals, largely a reflection of higher inflation expectations, with this figure set to increase further at 1 January.

Aon added that demand for additional limit at January renewals will likely exceed mid-year increases on a nominal basis, but the percent impact “may not be quite as significant”.

This view was shared by Lara Mowery, global head of distribution at Guy Carpenter, who said inflation was expected to lead to “one of the broadest shifts the [property reinsurance] market has ever experienced in a single year”.

She said “inflation and the drivers of evolving loss expectations” will be at the forefront of all negotiations. As a result, risk tolerances will continue to shift and demand is expected to increase, she said, noting that on an underlying basis, there were signs that rate increases are no longer keeping pace with inflation-driven increases in loss costs.

Mowery added: “While in the past we may have seen the industry flex to accommodate 3 to 5 percent growth in a given year without any strain, the 2023 ask of property reinsurers will be multiples of that.”

Aon’s Mike Van Slooten noted that inflation is pushing reinsurers to seek higher returns, putting upwards pressure on pricing and further constraining capacity for natural catastrophe risk.

Capacity constraints

The impacts of surging inflation are being faced at a time of reduced reinsurance capital. Gallagher Re found that total capital dedicated to the global reinsurance industry declined 11 percent to $647bn at half-year 2022, principally driven by substantial unrealised losses on investment portfolios.

James Kent, global CEO of Gallagher Re, said the steep headline decline in capital “overstates” the impact on economic capital positions but warned the figures nonetheless show the need for “continued vigilance given today’s macroeconomic and geopolitical uncertainties and the continuing debate over natural catastrophe exposures”.

While the majority of reinsurers have opted to maintain existing capacity levels, some have reduced or withdrawn their participation in the property catastrophe market (see above). Data from Aon noted that the strengthening of the dollar against the euro has particularly impacted European reinsurers’ capacity provisions in the run-up to 1 January.

Aon’s Van Slooten added that the resultant capacity crunch will mean insurers will have to find alternative sources of capital.

He said this means buyers are going to need to show “flexibility” at renewal, adding that some will need to consider all the forms of different capacity that are available in the market, whether that be traditional solutions, alternative capital solutions or parametric solutions.

“There’s lots of different options these days,” he said. “This isn’t going to be a ‘business as usual’ renewal, it’s going to be one where you’re going to have to think quite creatively in order to secure the capacity that you’re going to need.”

Climate change and secondary perils

Climate risk is another focus of the upcoming renewal. S&P analysis suggests that reinsurers are underestimating natural catastrophe risk by 33 percent to 50 percent, which could point to future volatility in earnings and the cost of reinsurance if reinsurers do not properly account for climate change in catastrophe models and pricing.

This was backed up by broker Howden, which found that cumulative insured losses since 2017 are now approaching $500bn – driven by the effects of climate change. It said that perils once regarded as ‘secondary’ or ‘non-peak’ have been the biggest component of loss since 2013 in all but one year – 2017. At the same time, losses from severe weather have come close to surpassing those from global tropical cyclones.

“The ‘primary’ and ‘secondary’ distinctions of the past are becoming increasingly redundant due to the effects of climate change,” it said in its latest research report, noting that losses in recent years from convective storms, floods, winter storms, derechos and wildfires, along with increased severity from more established risks such as tropical cyclones, have prompted some reinsurers to conclude that “price alone is not sufficient” to compensate for the volatility of cat business.

The impact of losses from the Russia-Ukraine conflict so soon after the market was rocked by Covid-19 has also contributed to the transitioning reinsurance cycle, the broker said.

“Coinciding with other external headwinds such as capital markets turmoil, war-related losses and a commodities crisis, the reinsurance sector enters peak hurricane season more exposed to losses and broader macro / geopolitical risks than it has been in the last 15 to 20 years,” it said.