Are reinsurers finally facing a reckoning?

If you thought inflation at 11 per cent was bad, talk to the insurers trying to secure cover in the natural catastrophe reinsurance market.

As the year’s big renewal event looms on January 1, property catastrophe reinsurance rates could rise not by the low double digits, but 20, 30, even 50 per cent, if Lloyd’s of London insurer Beazley is to be believed.

There are two schools of thought on this. One is that the market is dysfunctional with even underwriters struggling for reinsurance quotes. The other is that it is functioning exactly as it should.

Property catastrophe reinsurers, who provide cover to insurers, have had five bad years when earnings kept being wiped out by disasters. This past year was looking better until Hurricane Ian swept through Florida in late September, forcing around $50bn-$65bn in insured losses across the insurance and reinsurance markets. Average insured losses over the past 10 years are around $81bn, according to the Swiss Re Institute; this year looks like the second in a row where they will top $100bn.

Raising prices is a normal, totally understandable response, even if it is by as much as 50 per cent in a year. Insurance is a cyclical market. Prices popped after Hurricane Andrew in 1992, the World Trade Center attacks in 2001 and Katrina in 2005.

The curious thing is that despite five years of some of the largest insured losses on record, prices didn’t rise further. And now that they are, hardly any one wants in. Axis Re has stopped writing new property and catastrophe reinsurance business altogether. Scor is cutting back. So is Axa. A capacity crunch may already be here.

That’s usually the cue for capital to come flooding into the market and prices to fall again. What has tended to happen in previous cycles is that “soft” — cheap — markets have lasted for extended periods while “hard” markets of high prices have been short lived bursts of two or three years.

That could happen again. Next year might not be so bad for insured losses. It should be better for investment returns: the broad-based decline in asset values is one of the reasons capacity in the reinsurance market has contracted so sharply. Beazley launched a cash call last month so it could expand its capacity and catastrophe exposure.

But Beazley appears to be a relative anomaly. Instead, capital is drying up just as demand is rising. Inflation has pushed up valuations and the cost of meeting claims. More expensive property is now in the path of natural disasters.

One of the issues for insurers trying to pass on more of their risk is that investors just aren’t up for it in a rising interest rate environment. Part of the reason the market stayed soft through the past decade was that alternative sources of capital from hedge funds and the like provided extra capacity through catastrophe bonds and other similar products. But after years of heavy losses there are considerable amounts of trapped capital in insurance-linked securities, while higher interest rates are making reinsurance look a less attractive investment than it did. Other non-insurance assets are promising decent returns with less volatility.

It’s possible that better pricing improves returns for reinsurers, and that they manage to leave more risk with insurers in the first place. The problem, though, is pricing for climate change. Every year, insurers think they’ve got it right. If the past few are anything to go by, they haven’t.

It’s not just that climate change is a challenge because historic data are inadequate. It’s also that the type of risks that can trip up reinsurers are changing. Secondary perils — wildfires, for example, hail storms or flooding — are a particular problem. Those might not wipe out an insurer’s capital, but can kill off their annual profits — and are, with increasing frequency. On top of that, regions that weren’t so risky in the past now might be thanks to the pattern of urban development: as cities sprawl on to floodplains, for example. For some insurance investors, it’s just not worth writing the risk for now, regardless of the price rise. There is better boring business to be written.

That leaves a supply and demand mismatch that it is hard to see resolving quickly. But then, before five bad years came five quite good ones for the property catastrophe market. Investors can have short memories — even where a threat as fundamental as climate change is concerned.

cat.rutterpooley@ft.com

Climate Capital

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