Generational shift, cost-of reinsurance capital structurally reset upwards: Convergence panel

The insurance, reinsurance and insurance-linked securities (ILS) market is not hard, at least not in the traditional sense of the phrase hard market, but it has experienced a generational shift, with the cost of reinsurance capital structurally reset at higher levels, according to speakers at the recent Convergence event in Bermuda.

During a panel discussion on hard market dynamics, Lara Mowery, Global Head of Distribution at broker Guy Carpenter, said that “This isn’t actually a hard market, because a hard market is a market where you’re trying to buy a product and you can’t get that product at any price, it’s just not there and not available.”

She continued, “2023 saw, honestly, a generational shift in the way that property cat is viewed and written, structured, priced. So for a lot of people and especially a lot of clients, who are trying to buy that product, it does really feel like a hard market.

“But I think when you ask, is this hard market different from other hard markets, it goes back to what’s driving the lack of capacity, or need to increase pricing. What’s driving those dynamics.”

Mowery looked back to cite previous hard markets in reinsurance, where the market saw “people who could not buy reinsurance in the way that they had been buying for years before that.”

Previous hard markets had “true supply-demand imbalance,” Mowery said, but, “The market that we’re seeing right now, really isn’t necessarily about just scarcity of the product driving prices. It’s about the fact that the perception of risk and the way we measure the risk and how to structure a product to respond to that risk, has changed significantly.”

Mowery went on to highlight that a lack of a proactive response across the reinsurance market to loss trends may have been one driver of the hard market we’ve now seen.

“Capital perceived there wasn’t a way to support the structures and the pricing dynamics that were in place,” she explained.

Adding, “Probably if we were more proactive as a marketplace, you would have seen things like attachment points increasing by 5% a year every single year, or pricing increasing by 5%, as things like inflation and some of the other drivers started to come through.

“But that’s not what we saw, right? We saw very stagnant attachment points, and we saw decreasing price levels through 2015, 16, 17. So the correction happened all at once and that’s really created this dynamic of, okay, now we’re in a hard market, but the drivers of it really are different than what we’ve seen in past hard markets.”

All of which Mowery said plays into the sustainability of the hard market, as “this isn’t supply-demand”, which as we’ve seen in the past can result in rates softening more rapidly as capital starts to rebuild.

Mowery further explained, “There isn’t really a lack of capital in this space, but there is a lack of willingness to deploy that capital and there is a supply demand imbalance if you take the lower end of programmes and you say this is what buyers want to buy, down low what they’ve been buying for the last 10 years, there’s a lack of availability there because there’s no longer people willing to sell that.

“But overall, there isn’t a true desperate supply-demand imbalance like we saw in 2006.”

Also participating in this panel session at the Convergence event in Bermuda was John Seo of Fermat Capital Management.

Seo highlighted the issue of capital costs and investors demands for higher returns on capital nowadays.

“When you’re in the midst of a true hard market, there’s no availability at any price, and that’s not the case here.

“One of the things I believe in, is that simply the cost of capital for insurers and reinsurers has been reset, structurally reset. This is a once in a potentially even 50 year type of reset upwards.

“If you look at how the insurance side of the business in particular has evolved over the last 30 to 50 years, it’s global and it’s much more complex than it was back then and I’ve always thought that the capital markets, what they charged for capital to insurance companies was a bit stale, a bit behind the times and I think that we’re seeing a reset in that and that just flowing throughout the whole system.

“So, if I had to say one thing I would talk about cost of capital fundamentally is raised.”

Seo went on to call the current state of reinsurance and ILS a “hard-ish market” but added that more importantly “it’s a structural change”.

“So I don’t see that once this hard-ish market recovers, or you know capital in-flows, everything normalises, I don’t see it going back to the same baseline that held before,” Seo told the audience.

Responding to Seo, Mowery said that at the reinsurance renewals in 2023 firms like Guy Carpenter saw issues at the lower-end of programmes where there “simply wasn’t appetite to continue assuming greater and greater numbers of events.”

But, at the top-end, the issue Seo raised, of a higher cost-of-capital, was more evident.

Mowery commented that, “We also have, not an availability issue at the top-end, but a pricing issue at the top-end. Some buyers were shocked at where minimum rates online to buy up there went.

“But that’s exactly your point. Right? You have other things to do with the money, investors have other things now to do and what they can earn doing those other things is very different and the cost of capital for somebody to say, I’m I’m going to loan you my capital to protect you up here is very different than it was. So that created a pricing shift all the way through the curve.”

Seo asked whether it really is the ILS side of the market driving that top-end price in the reinsurance tower, or the traditional though.

Saying, “In my view, it’s the traditional side of the market that’s driving that.”

Matt Wilken, Chief Underwriting Officer at Hiscox Re & ILS, agreed, highlighting the competitive dynamics during the last soft market.

“There was no doubt in my mind that there was an ill-discipline in the market. So despite having eminently better ways of measuring risk and identifying risks, and despite having a purpose to be able to try and ensure that we are providing affordable capital to our cedents, so that they can transact their original policies to the men in the street and their homes and their houses and their businesses. We got to a situation where it was just really too much supply and the supply was basically chasing the prices down, classic Keynesian economics,” Wilkins said.

Adding, “So I’m delighted when we were afforded the opportunity of this more disciplined market to be able to make a much more cohesive argument to our capital, to say this is the cost of volatility. And sometimes that manifested itself into the top layer rate on line.”

Wilkins went on to say that the market was clearly underpricing risk in some areas, “There is also an element of uncertainty, and that uncertainty has a cost, and the market was trading that uncertainty too cheaply.”

Jessica Laird, Head of Property Cat at Nephila Capital was the final panellist participating in this session and she highlighted the issue of the market not keeping up with pricing risk commensurately.

“I think it’s important to think too about, let’s not always be playing catch up. There’s been so much correction to the risk assessment, that we’ve learned about in the last six to seven years, how we’re pricing for things, that we know the models miss inherently,” Laird said.

She went on to say that the market needs to identify the deficiencies in its analysis of risk, to ensure pricing is loaded in the right ways, to ensure coverage is sustainable and capital compensated as it needs to be.

“I think it’s important on the risk side to be thinking not just about what we’ve learned, but what do we need to be thinking about and anticipating for the future?” Laird explained.

Also read:

– Many ways to generate ILS alpha, but managing expectations key: Convergence panel.

– AI + computing power = exciting developments for ILS: Adrian Jones at Convergence.

– Responsible investors still require a minimum return: Convergence 2023.

– Significant investor interest. A wall of money, but slower moving: John Seo at Convergence.

– ILS market size matters. We need to make it scalable: Convergence panel.

– The “most pronounced” risk-adjusted ILS returns: Tangency’s Stanton at Convergence.

– Bermuda remains world-leader for cat bonds, ILS and Convergence.