Perspectives – Lara Mowery, Global Property Specialty Leader at Guy Carpenter

July 1 is the final opportunity for most insurers to buy reinsurance protection. This year's mid-year market has felt the effects of the changing capital landscape

mowery_lara_bioThe influx of non-traditional capacity and reduction in ILS pricing is altering how US cedants purchase their reinsurance protection, explains Guy Carpenter's Global Property Specialty Leader Lara Mowery. And while everyone agrees there is a floor to the current softening in rates, differing risk appetites and motivations make it almost impossible to predict when pricing will bottom out.

At June 1 average rates on line decreased by between 12.5% and 20%. Are we expecting similar softening at the upcoming July 1 renewals?

Every individual renewal has its own characteristics and set of circumstances that impact it but we saw pretty similar trends this year between the Florida renewals and the non Florida renewals in June and that same dynamic is really continuing for July.

One question coming into June and July was would the magnitude of the decreases that we had been seeing through the beginning of the year continue because June and July were really the first renewals that were fully impacted by the shifting conditions and decoupling of the cat bond pricing in March 2013. Would we see the same level of price decrease and same focus on conditions and types of coverage? And certainly we did see that. There was absolutely no slowing of the shift that's been occurring in terms of both pricing and overall market dynamics.

However, there were some signs of a floor being reached on certain deals as a handful of renewals had to re-price to get done. Some companies were very aggressive relative to what the market was ultimately willing to do. While there have been comments that “anything goes” in this market, we saw evidence that this is not the case. There is still underwriting taking place.

How does the relative pricing of collateralised reinsurance, rated reinsurance, cat bonds, retrocession and ILWs currently compare?

We see differences depending on the opportunities. There are given deals where the cat bond pricing for example is extremely attractive and traditional reinsurance or collateralised reinsurance perhaps isn't quite as attractive in terms of pricing.

But we also can see situations where the level of coverage or the way the insured is looking to structure coverage just isn't a very good fit for an ILS type product or product like an insurance linked warranty, where they are introducing basis risk into the equation. There are cases where the cat bond is maybe more expensive or doesn't provide quite the same coverage as a traditional reinsurer would.

There are more opportunities now to look at the way a company is transferring their risk and they are not all created equal and price is only one measurement within that category.

What sort of change are we seeing in buying behaviour at mid-year?

You are seeing an impact in terms of insurers evaluating what keeps them up at night and how they can buy coverage which best matches up with their core concerns. There's much more tailoring of coverage to individual company needs.

If you look at something like property catastrophe reinsurance and go back through the last several renewal seasons, there was more homogeneity in the terms and conditions around the product and the way people tended to structure the product. Not to say there wasn't ILS happening in this space, because there was at the time, but it wasn't driving the type of attention to detail and customer service and more specific tailoring of coverage that I think we see now.

There's potentially a longer-term change that may come about in the way that some companies (as they get comfortable with where the market is going) start to think about their own business strategies. This much more efficient use of reinsurance may lend itself to modifying their own longer-term strategies in their space.

We're definitely seeing increased interest in multiyear. With pricing levels as they stand insurers are now looking for stability in their longer-term pricing. Also reinsurers are more open to looking at multiyear strategies and so it's an interest on both sides of the equation that has been driving those discussions.

What proportion of their business are cedants placing with traditional reinsurers versus non-traditional?

Virtually all companies buying reinsurance are thoughtful about how much capacity they are going to put with any one provider or into any one product. I don't know there's one overarching trend in terms of split between traditional and alternative products - it's pretty varied depending on the client and the programme.

In one hand the collateralised products are collateralised so you've got that funding sitting in a trust account, which can be very heartening and secure for a client. On the other hand a lot of clients are still investigating what all that means. And it's not an inconsiderable process to go through issuing a cat bond. There's still a learning curve going on in terms of how to most efficiently structure and place that kind of business.

Are we seeing ILS branching out into new areas and how is this influencing renewals?

We definitely are seeing a growth in interest levels and sometimes we almost focus a little bit too much on how ILS is impacting the US space. You have collateralised reinsurers with interest in Europe and Asia who are writing business in those jurisdictions and certainly cat bonds have been put in place outside the US. So it's not necessarily just a US focus but a lot of the really significant impact in terms of pricing and limit deployed has been within the US.

How is the influx of collateralised capacity affecting traditional reinsurers?

Reinsurers are facing more competition and their own capital has continued to grow outside any impact from collateralised capacity. They are looking for ways to deploy that capital and have broad skill sets and great expertise in all classes and geographies.

As a result, renewals have become a more tailored and defined discussion between reinsurers and clients. Reinsurers are thinking about ways to structure coverage that best matches up to what clients’ needs are.

They are doing a lot more to think through solutions for things that may have been difficult to get coverage for in a way that companies were looking for. Midwest tornado hail aggregate coverage is one example and that is an area that collateralised markets don't focus on as much, but there have been a couple of products traditional reinsurers have pushed out there with again a lot of flexibility and tailoring around how those solutions would work.

How low can we go? Is there a natural floor to reinsurance and ILS pricing?

There absolutely is a floor because there's a business requirement to look at the amount of risk you're assuming. Pricing needs to stay in line to some degree with that measure of risk. The difficult part is defining what that floor is. There's not one consistent specific definition of how different companies measure this risk. There is still a fair amount of variability in cat model output and then the way that output is used and interpreted.

Because these events tend to be infrequent and in a lot of cases significantly large when they do happen, it's very difficult to say based on experience whether pricing is or isn't reasonable. So there's a fairly wide range of views around how measuring the risk translates into a price, because that measurement of risk can be different from entity to entity.

What a collateralised reinsurance or cat bond writer's goal may be, versus that of a traditional reinsurer, may also be different. They may have very divergent reasons for wanting to write the business and that impacts how they translate that measure of risk into a price.

How could pricing be impacted by a major event?

If you look back at 2011, it was a massive global loss year, but that didn't necessarily have a broader reinsurance market impact. It impacted those markets where the losses occurred but didn't necessarily shift the market overall. If we had a large earthquake somewhere outside the US would that be the thing to move pricing? I'm not sure it would be that impactful. Having the loss itself won’t necessarily translate into a price shock anymore in part because capital is so much more fluid now than in the past. However, having a major loss that challenges the current risk measurement assumptions and is very unexpected in some way may have more of an impact.

The attractiveness of other investment opportunities in a global economic sense may also have an impact. So there are things out there that will shape the space going forward, but I think the dynamics in terms of this capital coming in and the way that reinsurers and insurers are reacting is a longer-term proposition now. People are becoming more comfortable that this isn't fleeting capital.

Posted: Monday, June 30th, 2014