Reinsurers continue to actively shrink property cat exposures to avoid perils

A recent AM Best report suggests that companies continue to actively shrink their property cat exposures to avoid perils and reduce volatility.

Some have even modified their organizational structures or exited the property cat space altogether, though most of the largest European players remain committed to catastrophe risks and continue to grow.

Catastrophic risk is one where a large number of people are exposed to the risk of a large loss by reason of the occurrence of a peril. It could be a natural calamity in the form of earthquakes, floods, draughts or even terrorism attack resulting in loss of life, destruction of infrastructure on a large scale.

The report states that volatility in reinsurers’ results over the last few years has been driven by heightened natural catastrophe activity and an increase in secondary perils, such as floods and wildfires, as well as the COVID-19 pandemic and the more recent Ukraine-Russia conflict.

All of this, in addition to general financial, economic, social, and geopolitical uncertainty has led to a turning point in attitudes to risk

The instability of financial results and the inability of reinsurers to meet their cost of capital put the level of investors’ risk tolerance to the test, particularly evident in the insurance-linked securities (ILS) markets, which after a period of rapid expansion, plateaued and experienced a significant flight to quality when allocating capital.

AM best suggests that traditional markets’ risk appetite took longer to move in a similar direction due to the hope that natural catastrophe activity would subside and return to more average historical levels. But this simply hasn’t been the case, and AM Best notes that several factors complicated that picture, however, with secondary perils becoming more prominent than ever.

The accumulation of small to medium-sized events has had a material impact on claims ratios, sometimes at unexpected times of the year, or outside their usual geographical scope.

It’s not just that the underwriting environment is less predictable, says AM Best, Government actions are having a huge impact on market conditions. The business interruption and event cancellation losses related to COVID-19 were never factored into pandemic pricing models.

Capital is becoming tighter, AM best warns, with recession fears looming, and asset valuation declines hurting balance sheets in a way that catastrophe losses have thus far not been able to.

The perception of volatility and uncertainty has been magnified for reinsurers, on the asset and liability side of the balance sheet as well as on the bottom line.

Investors may not feel as comfortable as they did before these issues emerged, and this is even truer for catastrophe risks. When the frequency component rises beyond a certain tolerance threshold, investors will naturally reassess their positions and return expectations.

There should be a price high enough to compensate for that level of uncertainty, says Am best, but few reinsurers feel that rate increases have reached that point yet.

There is a strong preference for stable results over higher expected profit margins. Reinsurers have been shifting covers to higher layers of protection, raising deductibles, lowering limits, adding explicit exclusions, avoiding aggregate covers, restricting specific perils and geographies, and becoming more selective with their cedents.

Traditional reinsurers’ behaviour is consistent with what Am Best are also seeing in the ILS markets.

The investor base remains extremely cautious and selective despite some mixed messages about expanding cat bond issuance, and early signs of a small expansion in total alternative capital capacity after several years of stagnation.