Reinsurance market renewals
In 2020, the reinsurance industry experienced one of its most challenging periods in many years. Several years of high industry losses along with historical low interest rates have driven positive rate development and a shift to a hardening market within certain market segments.
Additionally, the global spread of COVID-19 and its impact on the global economy has added significant uncertainty to insurance coverage and losses and has further disrupted the reinsurance industry. As such, the reinsurance renewals for January 2021 provide a good insight into the condition of the reinsurance market with respect to pricing, capital flows, contract terms, and outlook for the remaining renewals throughout the year.
Each reinsurance renewal period brings its own unique challenges and opportunities, and this year’s renewal was no different. The January renewals are considered the most important renewal of the year in the reinsurance and ILS market. The majority of large global reinsurance programs and reinsurance contracts for select reinsurers in the U.S., Canada and Europe, are negotiated for the year during this period.
Over the past few years, the reinsurance market has experienced a shift in market sentiment with changing views of risk from past loss experience and constrained capacity. This has led to wide-ranging price improvements across various geographic markets and risk perils combined with a tightening of contract terms and stricter coverage conditions. These market attributes are reflective of the hardening witnessed in various reinsurance market segments over the past few years with cedants (companies ceding part or their risks to the reinsurance or ILS market) facing stricter market conditions. The most notable part in this development has been the retrocession market (reinsurance risk transfer to another reinsurer), which experienced even more pressure from loss events, trapped capital and even periodic dislocated market conditions with continued demand for capacity.
The market hardening from past loss experience was further exacerbated by COVID-19 in 2020. The pandemic outbreak, which appeared largely as an exogenous event to the industry, further disrupted an already stressed reinsurance industry. Insurance losses and ongoing uncertainty on ultimate loss levels from COVID-19 affected the reinsurance industry on both sides of the balance sheet, eroding solvency levels and forcing some reinsurers to recapitalize to strengthen their balance sheets.
COVID-19 therefore added a new dynamic to the reinsurance market, bringing more challenges to the January 2021 renewals. Uncertainty concerning liability for COVID-19 exposures and ultimate losses related to business interruption complicated contract negotiations. To some extent, a highly active event year in the U.S. with high frequency of low- and medium-sized insurance loss events, further supported expectations on rate increases for the 2021 renewals.
The January 2021 renewals were characterized by a shift in focus towards more disciplined underwriting with improvements in terms and conditions and a revision of contract wording in relation to potential claims “leakage”. The uncertainty on claims coverage from COVID-19 resulted in a stronger focus on contract language such as communicable disease exclusions and specific perils covered. Broader conditions were addressed as well with respect to collateral release terms along with stricter exclusion of cyber risk, following an active year of cyber-attacks and after COVID-19 revealed the extent of business interruption exposures.
Although the market largely exhibited discipline in underwriting, rate acceleration proved less than some market participants had expected. Despite high expectations, the renewal did not manage to achieve its full potential in further rate improvements in light of challenging market conditions as property rate increases ended up somewhat at the lower end of initial expectations, in particular for non-loss affected programs.
In the U.S., pricing generally improved versus expiring contracts continuing a modest market hardening, though at moderately lower levels than initially expected as new capacity mitigated support for more pronounced rate improvements. Nationwide U.S. reinsurance programs saw single digit rate improvements, whereas regional contracts achieved the most significant rate increases from some particularly loss-affected transactions, experiencing premium improvements of up to 25%. This was driven by higher than expected losses from the Derecho storm, which swept across the Midwest in August 2020. In Canada, on average, more significant rate increases of 10% to 20% were observed, following loss experience in 2020.
In Europe, some market hardening could be observed following several years of stable market conditions, with most contracts renewing with single digit rate increases and improvements in contractual wording. In the absence of major natural catastrophe events in Europe over the past years, this development can be attributed primarily to COVID-19 related losses, as we have observed a majority of such losses emerging from Europe. Nevertheless, the impending losses from COVID-19 did not lead to a significant hardening as this topic was largely postponed by market participants, due to ongoing uncertainty on loss levels at the time of negotiation. In the end, there was no shortage of capacity and most contracts were oversubscribed. Insurance companies generally bought more capacity at the top end of their program (i.e. lower risk layers).
Lastly, the retrocession market returned to more stable supply-demand conditions, despite initial uncertainty on further trapped capital on collateralized retrocession from COVID-19 losses. Overall, pricing continued to improve, but the market did not exhibit a dislocation as predicted. Demand reduced for the first time in years and adequate capacity from both the growth in supply from existing writers as well as capital inflows from new participants entering the market, which particularly targeted the higher risk layers. In addition, reinsurers increasingly drove a shift in demand towards cost-efficient alternative capital, such as retrocession catastrophe bonds with trigger structures based on industry indices, bringing alternative risk capital again to the foreground in mitigating risks in this market.
The near term outlook for the reinsurance market will continue to be dominated by uncertainty around the development of the global economy. Many reinsurers will continue to be challenged by monetary stimulus programs driving ongoing low interest rates in support of economic recovery from COVID-19, eroding investment yields and putting pressure on balance sheets. The industry will further remain affected by uncertainty on COVID-19 related losses, which may drive industry capital deterioration and reduction in reinsurance capacity.
For the alternative capital market, the 2021 renewal has shown to have evolved to a more efficient market with lower entry barriers and improved availability of capital within broader market segments. This could implicate less pronounced peaks through the reinsurance premium cycle in the future. Although the January 2021 renewals did not deliver on the high initial expectations, overall pricing improved with better terms and conditions driving future positive expected return potential for the ILS market.