In a challenging market environment, the reinsurance industry is grappling with several obstacles as catastrophe losses mount and reliance on external capital becomes increasingly weak, according to Swiss Re’s report titled “The State of Reinsurance Property Catastrophe market.”
Over the past two decades, low interest rates have fostered a greater appetite for risk in financial markets, leading to a large portion of the capital supporting catastrophic risk being taken from in alternative markets such as nest bonds and insurance-linked securities.
Swiss Re revealed that insured losses from natural disasters reached a staggering $125 billion in 2022, marking the fourth highest year for insured losses on record. The numbers were surpassed only by losses in 2005, 2011, and 2017.
Traditionally, the reinsurance market has relied on a self-funded model. However, with the increased involvement of external capital, reinsurer balance sheets have become more leveraged, leaving them vulnerable to short capital flows.
This change has changed the industry, making it more dependent on the availability of external capital leverage, thus creating risks and challenges.
The reinsurance sector is experiencing a fundamental change, where residual income has proven insufficient to cover the cost of capital, especially the strengthening of balance sheets to manage an expanding danger scene.
Since 2017, weather-related natural disasters have cost the re/insurance industry a staggering $650 billion (at 2022 prices) in claims.
Unfortunately, premium income has failed to keep pace with the increasing frequency and severity of these events, resulting in reduced industry profits.
Natural disaster losses have a direct impact on industrial capacity, reducing profits and capital supply. These losses also influence re/insurers and investors to re-evaluate their risk assessments. Concern over whether risks are sufficiently priced affects the supply of capital and the capacity available for underwriting.
The surge in catastrophe and claims activity since 2017 has raised doubts among re/insurers and investors, leading to a slowdown in capital supply. As a result, leveraged positions are winding down in the face of record losses from secondary risks and an unprecedented surge in inflation, which has reached a 40-year high.
Secondary hazards, such as weather-related disasters, cause losses that deviate significantly from traditional industry loss models. The magnitude of these losses between 1970 and 2022 is evident, reflecting the challenges faced by the re/insurance industry in managing such events.
Uncertainties surrounding modeling discipline and the adequacy of premium levels to meet rising loss costs and emerging secondary catastrophes have also dampened providers’ risk appetite.
Exacerbating these challenges is the persistently soft market experienced by the reinsurance industry, stemming from historically positive results. This allows primary insurers to be more leveraged in reinsurance protection at lower coverage levels.
As the balance of risk shifts between insurers and reinsurers, the insurance market becomes increasingly dependent on the reinsurance market, which, in turn, is dependent on the capital markets.
The beginning of this decade brought additional stress as reinsurers faced systemic and macroeconomic risks that had not been adequately priced, starting with the COVID-19 pandemic and the associated business disruption losses.
Subsequently, the effects of the war in Ukraine and an ongoing inflation shock exacerbated the pressure. Swiss Re economists predict that higher inflation will continue in 2023 and beyond.