Today’s soft reinsurance market has put increasing amounts of pressure on traditional reinsurers to develop new strategies and tactics to survive. Combined ratios are increasing, and it’s a sink or swim environment that can feel like a futile race to 100%. In this post we’ll take a look at some of the forces that have created today’s soft market conditions and connect them back to their effect on combined ratios.
When we say “soft market,” what we’re generally referring to is an underwriting environment in which premium rates are flat or declining; limits are high; insurance coverage is readily available; and consumers can choose between multiple offerings. Conversely, “hard market” refers to when the cost of premiums is increasing, there are lower limits, and consumers have fewer options. So what are some of the major causes of today’s soft market conditions that result in higher combined ratios?
The Forces at Work Affecting Combined Ratios
To remind you, here’s the formula for combined ratios:
And here are the forces we’ll discuss:
Figure 1: Several factors that have led to increasing combined ratios currently being realized in today’s soft insurance market. (Source: AIR)
A Lack of Major Catastrophic Events
A lack of major catastrophic events puts increasing pressure on the pricing of reinsurance rates. Years with fewer major events enable consumers to demand similar or better prices, which means reinsurance rates (premiums) fall, and thus the denominator in the equation above goes down and combined ratios increase.
Now, looking at the combined ratio formula, you might be wondering, wouldn’t fewer major catastrophes mean fewer incurred losses and thus lower the numerator in the combined ratio formula? Compared to a major catastrophe year, yes, but it’s important to remember that reinsurers take losses year in and year out, even when there might not be a large number of major catastrophes. But a dearth of major catastrophes will affect reinsurance rates in the next renewal period.
As we’ve seen, 2017 has had quite a few significant catastrophes, including major hurricanes Harvey, Irma, and Maria as well as major earthquakes in Mexico, so (re)insurers that write coverage in these affected regions will have higher insured losses and loss adjustment expenses this year. But you’re probably wondering what impact these events will have on the soft market conditions in the future. One or two of these events occurring in isolation may have only been felt by certain reinsurers that provided cover in the affected areas and may not have been enough to affect renewal rates. However, as more of these events have unfolded, many in the industry are expecting property catastrophe pricing to increase, with one analyst going so far as to predict double-digit rate increases. Whether these events are enough to shift the cycle of reinsurance to a hard market is yet to be seen and, as you’ll read below, there are other forces at work.
The inflow of alternative capital to the reinsurance market in recent years from the capital markets is staggering. By the end of June 2017, catastrophe bonds, reinsurance sidecars, industry loss warranties and other alternative risk transfer vehicles totaled USD 89 billion, which equals nearly 15% of the overall amount of global reinsurer capital. Thus, as shown in Figure 1, more competition results in declining premium rates, which again lowers the denominator of the combined ratio equation, meaning combined ratios will continue to increase.
Increasing Volume of Data to Process
As companies continue to write more risks, enter into markets, and investigate more claims, the amount of data being processed continues to grow and more resources—from people with the skills to process this data to the need to build new tools and systems for its analysis—are required. The investment of both time and money combing through more contracts and investing in new IT projects translates into increased operational costs, some of which are reflected in the “Other Underwriting Expenses” part of the equation.
Furthermore, because of the soft market conditions, catastrophe modelers, underwriters, and actuaries are forced to be less selective than they would be in a hard market. They have to spend significantly more time analyzing more loss data from more deals—deals that in a hard market they could decline outright without having to think twice about—to uncover the marginally more profitable ones.
An Increasingly Challenging Reinsurance Market
In sum, the lack of major catastrophic events, increasing competition from alternative capital sources, and increasing volumes of data to analyze and process, are a few of the forces that contribute to the increasing combined ratios that we see today.
So, other than making more money through investment income, what can you do to survive in today’s soft market and improve your core reinsurance operations?
The good news is, there is quite a bit you can do, and we’ve seen many of our clients use Analyze Re to identify and write more profitable business; retain more premium while buying outwards reinsurance; and invest in technologies that enable them to reduce expenses in the long run. In part two of this post, we’ll take a look at several strategies and tactics we’ve seen that can help reinsurers rise above the pack.