The reinsurance industry has been caught up in storm after storm in recent years. This year, it may get an umbrella.
Last year, weather-related events including Florida’s Hurricane Ian caused claims of about $120 billion for insurers, making it the third-costliest year for weather catastrophes, according to Fitch Ratings estimates. But the silver lining for the reinsurers that backstop a lot of catastrophe risk for other insurers is that—finally—their rates and terms may be able to significantly adjust to better reflect the elevated frequency and severity of losses in a changing climate.
There have been many big storms in recent years. But they haven’t come in a market environment quite like this one, with rapidly rising interest rates. That is having the effect of limiting the flow of capital into reinsurance and related instruments. Nonspecialist investors have sought out yield in the form of products such as catastrophe bonds, which pay interest but can lose their principal if they are triggered by a “cat” event. Those investors can now find yield in more-traditional places. For years, that influx of loss-absorbing capital had made it much harder to price risk to consistently cover losses. But that may be changing now: Dedicated reinsurance capital shrank about 15% in 2022 to $355 billion, the first year-over-year decline since 2008, according to estimates in a report by international insurance and reinsurance broker Howden.
The upshot: higher prices for reinsurance during the traditional contract renewal period at the start of the year. Howden estimates there was a 37% risk-adjusted global rate increase across Jan. 1 property-catastrophe reinsurance renewal deals, along with stricter terms around when reinsurance is triggered or how much loss it covers. That would make this year the “hardest” reinsurance market, in industry parlance, since the early 1990s. Reinsurance stocks have already jumped since Ian hit, partly in anticipation of this effect. Shares of Arch Capital Group, Everest Re Group and RenaissanceRe Holdings are all up by more than 30% over the past three months.
Of course, the formula isn’t quite so simple as higher prices, more profit. Reinsurers can themselves be consumers or users of reinsurance in many forms, often as a way to increase their capacity. Some reinsurers use retrocession, or “retro,” which is basically reinsurance for reinsurers. Others join with or sell risk to investors in the insurance-linked securities market, which includes cat bonds. So shrinking capital for the industry also can shrink the business for reinsurers, too.
RenaissanceRe, for example, has in the past purchased retro protection. Chief Executive Kevin O’Donnell said last year that a “material reduction of capital in this market” will make this insurance “less available and more expensive in 2023.” The company plans to purchase less retro and “take more risk” on net, he said, while “increased rate and better terms and conditions will be far better tools to control and shape our portfolio.”
So how much will higher rates actually translate into additional revenue dollars and, ultimately, underwriting profit? Even if reinsurance rates broadly jumped 40%, revenue in the first quarter might jump only by single digits, according to Bank of America analyst Joshua Shanker. Moreover, rates aren’t the only consideration. There is also just what those rates are paying to cover.
Thus the real measure of improved economics might not come in the next earnings report. “You may not be able to witness the power of new pricing dynamics until a major catastrophe hits,” says Mr. Shanker. Fitch expects reinsurers’ industry combined ratio, or what insurers pay out as a percentage of the premiums they collect, to improve from just over 98% last year to 94% in 2023.
Rising reinsurance costs might also put further pressure on the cost of the primary insurance that many people buy for their homes or cars. At least owning reinsurance stocks could offset some of that risk.