Strengthening the safety net – adequately pricing property reinsurance for an insurance market

If insurance is the tool that helps the world’s businesses cushion themselves from risks, then reinsurance is the safety net holding it all together.

Just as a safety net protects individuals from daring, high-wire feats, reinsurance is designed to protect insurers and their clients from natural catastrophes and other unexpected events that can result in large losses.

Adequately priced reinsurance is critical to create balance and maintain a sustainable primary property insurance market, according to Tehya Duckworth (pictured), SVP, property underwriting manager at Munich Re US.

“The cost of reinsurance gets reflected in the primary rates,” Duckworth said. “If we don’t measure and quantify risk correctly at each point, from the reinsurance company to the primary insurer and the end-policyholder, there could be consequences such as increased morale hazard, deterioration of industry results, and ultimately, reduced capacity. Inadequately priced reinsurance could result in the loss of the cohesion of benefits of a proper risk transfer system. The principle of indemnity can break down.”

Florida’s cautionary tale against inadequate pricing

Reinsurance prices include reinsurer expenses, which are easily quantifiable and measurable. The loss component represents expected losses and a risk load, which captures the uncertainty or volatility of the expected losses.

The latter two are where the unknowns lie, and what makes pricing reinsurance challenging, which is why Reinsurers need to have a thorough grasp of the risk factors underpinning each policy.

“As a reinsurer, we need to properly understand, appropriately measure, and charge for not only the expected loss but also the volatility (frequency/severity) or the uncertainty of loss,” Duckworth said.

On the other hand, inadequately priced reinsurance can occur when reinsurers are not considering unknown risks that could later turn out to be substantial shocks or when prices have been driven down unnecessarily by competitive forces.

A downward spiral caused by inadequate pricing could potentially see property markets end up like Florida, according to Duckworth.

“There was a period of reduced severe weather events, which led to complacency in the reinsurance pricing for the Florida market. It’s important to note that the risk of severe weather events had not decreased, yet primary insurers prices followed suit. As a result, when the severe weather hit, insolvencies accelerated. Additionally, negative behaviours associated with legal system abuse became the norm.”

Duckworth said that if reinsurers and insurers had maintained risk adequate pricing, it could have helped to stabilize the property market, preventing some of the aforementioned consequences.

Three benefits of adequate reinsurance pricing

Aside from providing a strong and stable safety net for the primary insurance market and its policyholders, adequate reinsurance pricing has other industry benefits:

Puts stronger emphasis on resilience

As inflation and supply chain disruptions push up the prices of raw materials and repairs, the cost of claims will rise accordingly. Homeowners and businesses will continue to see their insurance costs increase unless they take steps to reduce their risks.

Adequately priced reinsurance and insurance can incentivize the property industry to invest more into becoming resilient from extreme weather and other exposures.

“Resilience is probably the best way you can reduce the expected loss and increase the certainty [around risks], because if you’ve constructed a home in such a way that it’s not going to fall over or apart when the wind blows, then you have reduced your risk,” said Duckworth.

“Resilience not only helps the financial ecosystem by reducing insurance costs, but more important, helps communities continue to flourish.”

Encourages capital flow and promotes innovation

Reinsurance drives innovation in insurance by providing insurers with access to additional capital, enabling them to take on more significant risks and offer more comprehensive coverage to clients.

The knock-on effect of more capital flow in the insurance industry is innovation and growth. Armed with more capital, insurers can develop more innovative insurance products, which encourages competition and provides consumers with greater options.

“When we have more capital flowing in the industry, then we can start to invest in innovative tools that are going to help us better understand risks and create better products that fill protection gaps, such as in the flood and earthquake markets,” said Duckworth. But the industry must generate sufficient returns to garner that capital.

Adequately priced reinsurance cuts down unnecessary volatility in the market cycle that leads to extreme periods of coverage expansion and contraction.

The result? A market that is far less disruptive to insurance clients and their policyholders.

Reinsurers and insurers alike have a responsibility for risk adequate pricing throughout the market cycle, according to Duckworth.

“If discipline wanes, and as a result, prices drop to a level of inadequacy, it can lead to an extreme contraction of capacity, which can result in the market swinging too far in the other direction,” noted Duckworth.

Adequate pricing for stable and long-term partnerships

Ultimately, adequately priced reinsurance is critical because it allows reinsurers to continue taking on insurer’s risks. Without the safety net of reinsurance, many insurers would find themselves unable to hold as much risk as they currently do.

“Some insurers will look at their portfolios and say, ‘How am I going to buy my reinsurance?’ If they can’t place the reinsurance, that can become an existential crisis,” said Duckworth.

Munich Re US will continue being a long-term and stable partner for its primary insurance partners.

The material presented here reflects projections based on assumptions and forecasts and is intended for information purposes only.  It is neither intended to be nor shall it be construed to be legal, underwriting, financial or any other type of professional advice.  Neither Munich Reinsurance America, Inc. nor its parent or affiliates makes any representation or warranty of any kind, whether express or implied, with respect to the accuracy, completeness, or applicability of this material to any recipient’s circumstances.                                                                                    

Tehya Duckworth currently leads a team of treaty underwriters for Munich Re US and manages a diverse portfolio that includes small regional companies up to large national household names.  While her portfolio is equally broad in geography and coverage, spanning admitted personal lines to commercial E&S, she has focused responsibility for the development and execution of strategies for the Florida, TX & Gulf, Farm Bureau, and NAT CAT Pool segments as well as the Wildfire and Severe Convective Storm Perils.

Prior to her time at Munich Re US, Tehya spent over fifteen years at American Modern Insurance Group, where she spent five of those years leading a team of specialists and cat modelers as a Vice President, Head of Portfolio Management & Reinsurance. During her tenure, Tehya also served as the Head of Reserving for six years and served in other actuarial roles.  Prior to American Modern, she spent some time at Indiana Insurance (part of the Liberty Mutual Group) and started her career at CNA.

Tehya is a Fellow of the Casualty Actuarial Society and a Member of the American Academy of Actuaries.  She earned her MBA from Northern Kentucky University and her BA in Mathematics from Hanover College.