Repriced and restructured reinsurance means lower risk to investor returns: RBC

The fact reinsurance arrangements have been thoroughly repriced and restructured over the last two years means that, as we move into the second-half and what can often be the heaviest loss period, there is a lower risk that the returns from reinsurance are affected, as primary carriers are set to retain more losses again this year.

This is according to equity analysts at RBC Capital Markets, who say they believe most catastrophe losses will be retained by the primary tier of the insurance and reinsurance marketplace.

The analysts are, of course, writing for equity investors, but this translates across positively for insurance-linked securities (ILS) investors as well, as the same adjustments to reinsurance contract and program structure, as well as repricing, flow to the benefit of catastrophe bond and ILS investors as well.

With hurricane season upon us, the industry and its capital providers may see examples of how this plays out (which may be the case with Beryl).

We’ve already seen it with the severe weather season, as despite over $31 billion in US convective storm losses so far this year, very little has fallen to the reinsurance and ILS market so far, aside from via proportional arrangements like quota shares, with losses still minor there as well.

RBC Capital Markets analyst team explained, “Nat cat losses in aggregate appear to be running broadly in-line with historical averages for 2Q, and appear to be dominated by mostly frequency events for the most part.

“Repriced and restructured reinsurance contracts mean that we expect most of the cat losses to be retained by primary insurers, as seen at 1Q.”

For capital providers, this means a buffer has been created in reinsurers loss allowances, which again translates across to the ILS market, as investors have benefited from returns through the first-half, building a buffer against some losses through the wind season.

This can serve to “to absorb potential shocks in 3/4Q” the analysts explained.

Stable renewals at the beginning and middle of 2024 mean that the RBC analysts maintain their favourable outlook for the reinsurance market, they say.

Mid-year commentary was “mildly positive for US cat risks” as rates were flatter, with less sign of a concerted decline.

“The active hurricane season forecasts appeared to have influenced this,” the analysts said. Adding that, “Separately, policy terms and structures stuck albeit this was expected.

“Looking ahead, we expect underwriting conditions to remain highly conducive, even if rates start to moderate slightly (but remain at least in-line with loss trends).

“As is the case every year, the outcome of hurricane season is a key driver of the renewals outlook at this stage although reassuringly it appears the market discipline is being preserved which should sustain a minimum level of rate adequacy regardless of the outcome.”

Summing up, the reinsurance industry has more buffers in place to deliver on its return promises, due to continued higher pricing, still stricter coverage terms, and the relatively average loss burden suffered so far this year, which bodes well for ILS funds and investors as well.

It only takes one storm to change that, of course. But should that happen we’d expect (most analysts do too) a re-acceleration of rates and pricing in 2025.