Changes to reinsurance-related capital requirements proposed by the Australian Prudential Regulation Authority (APRA) could strengthen Australian general insurers’ credit profiles in the medium term, according to Fitch Ratings report. This depends on whether the changes improve access to reinsurance protection.
Reinsurance provides significant benefit to Australian insurers and policyholders. It provides stability to the general insurance industry by assisting insurers to manage risk and to meet capital requirements
The pricing of catastrophe reinsurance, alongside the frequency, severity, and costs of natural disasters, will continue to influence insurers’ willingness to purchase reinsurance. These factors will determine the long-term effects on their capital and earnings.
Aon estimates that global reinsurer capital rose by $25 bn to a new high of $695 bn over 2024. The increase was principally driven by retained earnings, recovering asset values and new inflows to the catastrophe bond market, according to Reinsurance Market Trends Report.
Underlying ROEs were materially higher due to a further reduction in underlying combined ratios and higher recurring investment income.
The better natural catastrophe experience of the reinsurers stands in sharp contrast to overall insured natural catastrophe losses.
APRA’s Proposed Reinsurance Reforms
The APRA is consulting on targeted adjustments to its general insurance reinsurance framework. These proposed changes aim to enhance insurers’ access to various reinsurance options and reduce regulatory burdens.
Key aspects under consideration include:
- All-Perils Requirement: Allowing insurers to calculate the 1-in-200-year loss for the largest single peril and purchase all-perils reinsurance up to that level.
- Reinstatement Requirement: Lowering the return period for which reinstatement is required, potentially to a 1-in-100-year loss, acknowledging the low probability of two such events occurring within a year.
- Reinstatement Premium Requirement: Removing the need to include additional reinstatement premiums in the Insurance Concentration Risk Charge (ICRC).
APRA is also considering technical updates to streamline processes, improve transparency, and clarify expectations. These updates aim to reduce regulatory burdens and ensure consistency across the industry. Stakeholders are invited to provide feedback on these proposals by 17 February 2025.
In recent years, the global reinsurance market has been challenged by a range of factors including the increased impact of severe weather events and rising geopolitical instability.
These factors have at times contributed to a significant hardening of the reinsurance market in Australia and globally, reflected in higher retentions and increased reinsurance costs, putting further pressure on GI availability and affordability challenges.
Potential targeted adjustments
APRA is consulting on targeted adjustments to its GI reinsurance framework. APRA seeks:
- general feedback on adjustments to APRA’s GI reinsurance settings and processes that would assist insurers in accessing reinsurance; and
- specific feedback on adjustments in relation to APRA’s GI reinsurance eligibility criteria detailed in Attachment A.
Any adjustment to the prudential framework will be assessed in line with the following objectives:
- promoting access to all forms of reinsurance solutions whilst ensuring insurers’ financial resilience is maintained in alignment with the object of the current insurance capital framework;
- reducing regulatory burden and improving transparency for industry; and
- ensuring consistency with international standards and practice.
APRA is also proposing to make technical updates to the GI reinsurance framework.
To date, general insurers have largely utilised traditional reinsurance solutions. To continue to access appropriate, cost-effective reinsurance, industry has expressed appetite for alternative reinsurance arrangements.
APRA reminded insurers that APRA’s prudential standards permit the use of alternative reinsurance arrangements, such as catastrophe bonds and other types of Insurance Linked Securities (ILS), and invited insurers to engage with APRA should they wish to use alternative reinsurance arrangements.
Industry feedback has indicated that aspects of APRA’s prudential framework present challenges to accessing the full suite of available reinsurance solutions.
All-perils reinsurance coverage
APRA launched consultations on planned reforms that would require general insurers to buy all-perils reinsurance coverage, while lowering reinstatement requirements and removing the requirement to hold reinstatement premiums as part of the insurance concentration risk charge (ICRC). Any new standards would not come into effect until June 2026.
The proposal may encourage insurers to consider alternative reinsurance solutions, such as catastrophe bonds and other insurance-linked securities. APRA highlighted these options in August 2023.
However, adoption of alternative structures in Australia has been limited, even as the global market grows. Current regulations around reinstatement requirements for catastrophe reinsurance may partly explain this. Alternative structures typically lack reinstatements, making APRA’s proposal to lower reinstatement requirements potentially advantageous for this segment.
Asia-Pacific insurers plan to increase asset allocations
Asia-Pacific insurers plan to increase asset allocations to fixed-income investments over the next 12-18 months, in order to take advantage of rising yields and reduce their asset-liability duration mismatches.
APAC insurers’ underwriting fundamentals are likely to remain steady despite short-term volatility in investment markets caused by higher interest rates, Fitch Ratings says. At the same time, headwinds from Covid-19 and related measures are easing.
APAC insurers’ capital and profitability metrics were affected by adverse market movements caused by the recent increase in interest rates. Insurers booked large unrealised losses on lower fixed-income and real asset valuations.
According to Moody’s, APAC insurers would increasingly need to consider the features of their policy liabilities in devising strategies for asset allocations as they prepare for more stringent capital requirements under new advanced risk-based capital regimes, as well as IFRS 17.
Moody’s survey to rated insurers in four markets in Asia-Pacific, shows that insurers will remain disciplined in asset and liability management as rates continue to rise.
Rising catastrophe reinsurance costs
Rising catastrophe reinsurance costs have prompted insurers to increase retention limits, exposing earnings and capital to greater risk.
For example, Suncorp Group Limited raised net retention under its primary catastrophe reinsurance program for the fiscal year ending June 2024 from AUD250 mn to AUD350 mn.
It also declined to renew its aggregate excess of loss reinsurance, which provides coverage after multiple smaller events.
The rise in reinsurance costs for APAC insurers reflects the growing frequency and severity of extreme weather events. While reduced reinstatement requirements may lower costs, the overall impact remains uncertain.
Capacity constraints may also limit availability; global reinsurers showed reduced appetite for all-perils coverage during 2023 renewals.
Requiring all-perils reinsurance instead of named perils could increase costs. Regulatory changes alone may not lower reinsurance costs if reinsurers continue to face escalating catastrophe losses.
The regulatory capital positions of most of our rated insurers remain above rating sensitivities and well above regulatory minimums.
Analyics expect the adverse impact of higher market rates on capital to be mitigated under IFRS 17, as the liability valuations will better reflect prevailing interest rates.
Insurers’ reinsurance strategies
Insurers’ reinsurance strategies are also shaped by internal risk tolerance and capital requirements from rating agencies. Where these factors dominate decisions on catastrophe risk retention, APRA’s proposals may have limited impact on retention levels.
APRA currently mandates capital to cover a one-in-200-year loss on a portfolio basis, granting capital credit for reinsurance covering such losses.
In New Zealand, where Australian insurers’ subsidiaries dominate, capital requirements account for one-in-1,000-year earthquake events, as set by the Reserve Bank of New Zealand.
More reinsurance options could help insurers manage net exposure without significantly raising net retentions or probable maximum loss (PML) values. This would support credit profiles by keeping net catastrophe exposure within manageable levels.
Fitch’s Prism Global model, which evaluates insurers’ capitalisation, considers catastrophe risk through net PML. Measures that prevent significant increases in net PML could sustain current ratings.
Insurers face greater risks to capital and earnings if successive severe catastrophes occur (e.g., one-in-200-year events) without reinstatement coverage.
Fitch considers this risk low, given the rarity of such events. However, the increasing frequency and severity of natural disasters introduce uncertainty to this assumption.
FAQ
The proposed changes aim to improve access to reinsurance protection and reduce regulatory burdens. This could enhance insurers’ ability to manage risks effectively, thereby supporting their capital positions and credit profiles over the medium term.
The reforms include requiring insurers to purchase all-perils reinsurance, reducing reinstatement requirements to a 1-in-100-year loss, and removing reinstatement premiums from the Insurance Concentration Risk Charge (ICRC). These measures aim to provide greater flexibility in reinsurance options.
Reinsurance stabilizes the insurance industry by helping insurers manage catastrophic risks and meet capital requirements. It protects insurers’ financial health and ensures claims can be paid even after severe disasters.
Increasing reinsurance costs, driven by the frequency and severity of natural disasters, have led insurers to raise retention limits. This exposes their earnings and capital to greater risk. Regulatory changes may mitigate some costs, but the overall impact depends on market conditions and reinsurer capacity.
The proposed reduction in reinstatement requirements could make alternative reinsurance solutions more appealing. These structures, such as catastrophe bonds, often lack reinstatement provisions, and APRA’s changes may facilitate their adoption in Australia.
Internal risk tolerance, rating agency capital requirements, and market conditions significantly influence reinsurance strategies. Even with regulatory changes, these factors may limit the reforms’ impact on retention rates.
APRA mandates capital to cover a 1-in-200-year loss, while New Zealand’s Reserve Bank requires insurers to hold capital for a 1-in-1,000-year earthquake event. Both frameworks aim to ensure sufficient capital to manage catastrophic risks effectively.
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AUTHORS: Kanishka de Silva – Director in the Insurance division at Fitch Ratings, Duncan Innes-Ker – Senior Director, Fitch Wire at Fitch Ratings
