Industry must tackle European catastrophe loss creep issue: Swiss Re

Global reinsurance giant Swiss Re has called for an industry focus on the issue of loss creep after natural catastrophe events in Europe, saying it is an “industry-wide phenomenon”, that shows the need for more up-to-date insured values to be used and for better information flow along the market chain.

Writing in a paper, Rita Müller, Head Claims Western & Southern Europe, and Balz Grollimund, Head Catastrophe Perils, both of Swiss Re, explain that recent insurance industry loss creep after European catastrophe events risks the industry’s reputation.

Using the example of the Italian severe convective storms and hail losses from July 2023, they explain that here the industry loss estimate began at US $2.2 billion, but has now ballooned to near US $6 billion.

“This loss creep is an extraordinary example of an issue that is gripping the insurance industry – and one that we need to urgently tackle to safeguard the industry’s reputation and resilience,” Müller and Grollimund wrote.

They say that loss creep is an industry-wide phenomenon, in fact stating it is a “problem” that requires focus across the industry to curtail it.

Loss creep has been evident in numerous large European insured catastrophe loss estimates over recent years and the problem extends beyond Italy’s hail experience, with loss creep after the 2021 flooding in Germany, the French hail in summer 2022 and more recently the Turkey/Syria earthquakes in 2023.

The paper explains, “When it comes to extreme weather events as we have seen in Italy, loss creep fundamentally boils down to the massive underestimation of loss exposure, risk values and inflationary impact. This was exacerbated by insufficient availability of loss adjusters, experts, builders and building materials as well as a lack of claims handling resources at these times of high demand. And although the industry has recognised the growing prevalence of loss creep for some years, it has largely failed to act on many of its drivers.”

Adding, “Given the magnitude of the loss creep issue, we believe the situation needs to be addressed.”

“This is a market-wide problem,” explained Müller. “As an industry, we need to get better in the early estimation of the real loss exposure after an event. Ongoing underestimation of losses leads not only to underpricing but also to a loss of trust in the industry. As we expect more extreme weather events in the future, systemic loss creep is not acceptable and not sustainable for our industry.”

A lack of data on up-to-date exposure and risk values is a key driver of this loss creep, Swiss Re believes, with outdated data often used and insurance and reinsurance market participants relying on industry loss data from previous events to model new losses.

“Insurance companies report very little about their exposure to hail in Italy to their reinsurers, for example. For some, we don’t receive any information at all. For others, we just receive very broad information that covers a large area. Only a small number provide this information on a zip code level,” explained Grollimund.

In addition, a lack of transparency between parties in the chain also hinders flow and accuracy, resulting in underestimates, Swiss Re’s executives state in their paper.

Inflation has been an added complication in recent years, while again the industry’s habit of looking back to estimate current occurrences has proven to be fallible.

“We have seen insurers base their initial reserve estimations in French severe convective storms in 2022 on a reserving model from an event that happened in 2014,” Müller said. “You can’t do that. You have to take repair cost inflation, the increase and concentration of values and all other up-to-date exposure factors into account.”

In that example, the 2014 event drove a US $1.4 billion insured loss, while the 2022 event totalled US $5.5 billion, Swiss Re data shows.

“Coordinated action” is needed to limit catastrophe loss creep, the pair explain.

Tackling data and transparency issues is key, as too is ensuring up-to-date values are used for exposure and risk.

A clearer view of the true cost can also enable much more accurate pricing by insurance and reinsurance markets, ensuring companies are paid more accurately for the risks they assume.

At the same time, initial reserving needs a refresh and can’t be so reliant on past event data, especially when it is from a number of year’s prior.

Models need to take account of “the real exposure at risk, including up-to-date inflation assumptions” the paper explains.

“It’s about getting a few very basic things right from the start,” Grollimund says. “We need to be diligent from the beginning of the value chain to the end about insured risks. We need to have frequent reassessments of the sums insured. And reassessments of what is actually covered by a policy.”

Preventing loss creep of this magnitude will ensure “the sustainability of our exposure assessment and pricing in the industry, while also offering fair premiums and adequate self-retentions for insurer,” the paper explains.

Müller explains why this is important for the reinsurance industry, “As we have seen in the Italy July 2023 storm events, reinsurers are especially hit by underestimation of an event and the subsequent loss creep as they carry the majority of the total loss burden.”

This call to action on loss creep is just as important and relevant for the insurance-linked securities (ILS) market as it is for traditional reinsurance players. It’s also worth noting that catastrophe and weather loss creep in regions of the world outside of Europe can also be significant and present an issue.

It is only by having the data as accurate as possible, including assumptions related to inflation, that risks can be properly priced and contracts structured to support cedents. It also has a bearing on where attachments are set, which reads across to the entire marketplace.

ILS fund managers have already experienced how prolonged loss creep can hurt them when capital gets trapped for the duration of the development. The uncertainty this creates and the drag on portfolio performance can be a significant issue and inaccurate approaches to initial reserving can be a real issue here, especially where an investment assumed likely to be safe, ends up facing losses thanks to significant creep.

Putting capital at-risk based on legacy data, outdated values, and incorrect assumptions can only end in tears. The industry would do well to heed Swiss Re’s caution here.