Heading into January's reinsurance renewals, there was little doubt that reinsurance pricing would continue to harden given the perfect storm that hit the sector in 2022 and in view of the various other challenges the sector has faced since 2017. The confluence of the Russia-Ukraine conflict, persistent inflation, mark-to-market investment losses eroding capitalization, and another above average catastrophe year including devastating Hurricane Ian all signaled pricing pressures, with tough negotiations all but assured. However, global reinsurers' operating results were below par for several years--not just 2022--owing to higher frequency and more severe natural catastrophes, mounting losses from secondary unmodeled perils (such as wildfires, floods, and convective storms), loss creep, COVID-19-related losses, and adverse loss trends in certain U.S. casualty lines.

All of these factors, plus historically low interest rates, resulted in reinsurers failing to earn their cost of capital in the past five out of six years (2017-2022), driving S&P Global Ratings' negative view on the global reinsurance sector (see "Is The Global Reinsurance Sector About To Turn A Corner?," Sept. 6, 2022). The question now is whether the pricing improvements are sustainable, and whether they are enough to combat the endless headwinds the sector has faced that have muted performance for the past several years. Even though we are cautiously optimistic, we believe it is not done and dusted yet--reinsurers need to maintain underwriting discipline, proactively take underwriting actions, and continue to seek price adequacy in the upcoming renewals.

It appears that the hard market is here, particularly in the short tail lines (property and property catastrophe lines). It's not just significant rate increases that were in favor for reinsurers, but also terms and conditions, coverages, and limits. It seems that the global reinsurers have run out of patience after trying to catch up with the increasing lost cost trends over the past several years, resulting in multidecade high rate increases in property catastrophe during the January renewals.

At the same time, during the January renewals, cedents' demand was up, but reinsurers were disciplined, focused on exposure management, and have taken a somewhat uniform approach to pricing actions, rather than a regional one as was the case in past years. Reinsurers have preferred to write middle and upper layers, thereby moving up on the attachment points, to limit their exposure to frequency losses and hedge against inflation. Terms and conditions have tightened with clear wordings for specific risk coverage, and emphasis was given for named peril coverage. We believe the significant price increases, along with these portfolio underwriting actions, will boost reinsurers' underwriting performance in 2023. In addition, the high interest rates should propel investment income, offsetting the moderating rate increases in some of the U.S. long-tail casualty lines.

We believe reinsurance pricing momentum will continue for the upcoming renewals in 2023. However, reinsurance capacity remains constrained on the property side. The competitive pressure from the alternative capital market, particularly the collateralized reinsurance and sidecars, has somewhat abated because that market is dislocated after facing a string of catastrophe losses and the resulting trapped capital and loss fatigue. Investors, especially in collateralized reinsurance and sidecars, have suffered significant losses over the past few years and are questioning the sponsors' underwriting and modeling capabilities and becoming more stringent in their selection of who to partner with. As a result, some investors have reduced their exposure to these catastrophe risk vehicles or completely exited this market. Others have decided to switch to catastrophe bonds, which provide more transparency, liquidity, and attractive returns.

Multidecade High Pricing Increases In Short Tail Lines

All parties found this January's renewals incredibly challenging, with renewals stretching later than prior years. It comes as no surprise that the short tail lines were going to be the most challenging. These achieved significant rate improvements, with the largest increases seen in property catastrophe lines. According to certain industry executives, 2023 renewals rival those of 2006 in the aftermath of the 2005 Hurricanes Katrina, Rita, and Wilma. However, unlike 2006 when increases were mostly in the U.S., January 2023 renewals price increases were global and broad.

U.S. property catastrophe saw significant rate increases this January. Global reinsurers were also pleasantly surprised by better-than-expected pricing in other regions, including Canada, Europe, Latin America, and Asia, but it still lagged the U.S. The first and second layers were hard to place, and for many cedents their second layer became their first. As a result, cedents have increased their retentions because of the growing price tag of protection. Furthermore, reinsurers increased substantially their minimum premium requirements for top layers in response to their rising cost of capital. In this context, pricing power has shifted to reinsurers from cedents.

Table 1

During the 2022 Monte Carlo Rendez-Vous de Septembre--the largest conference of reinsurers--the talk of the town was that there would be $10 billion to $20 billion of new capacity needed during January 2023 renewals. This additional new demand was expected to come from U.S. national insurance carriers to cover increasing replacement values exacerbated by inflation. But this new demand did not materialize. However, reinsurers believe that it is just a matter of when, not if. Maybe brokers/cedents are delaying the placement of this coverage hoping not to further harden an already firm property market.

The property catastrophe market has been imbalanced, especially for the retrocession market. Capacity has been severely dislocated with no new capital coming in as some reinsurers have exited altogether and seek less volatile lines after repeatedly being burned. As a result, retrocession pricing was up significantly. This dislocation is likely not to be resolved in the following renewals, and that could support reinsurance rate momentum throughout 2023.

Unlike property, the balance of power remained with cedents as casualty reinsurance capacity was plentiful with reinsurers' increased appetite for this segment. Casualty lines saw more orderly renewals because reinsurers, like their cedents/primary insurers, have enjoyed compounded rate increases over the past few years, though rate increases have moderated in the U.S. Reinsurers continued to push for more reductions in ceding commissions, which have improved by about 100-200 basis points compared with 2022 but remain relatively high (down to 32% from 34%) compared with historical levels (about 28% 10 years ago). Nonetheless, high investment income due to rising bond yields will somewhat compensate for the moderating price increases in the U.S. for reinsurers.

Specialty lines renewals were unique and saw dislocation in certain lines. Large rate increases in aviation, political violence, and terror were due to the Russia-Ukraine conflict fundamentally changing the view of risk for those lines of business. On the other hand, there is an influx of capacity in cyber reinsurance, which benefited from significant rate increases (30%-50%) in 2022 with expected additional rate increases in 2023, though at a substantially slower pace (5%-10%).

Reinsurers fared well during renewals with a strong focus on optimizing their portfolios, taking globally uniformed pricing actions, and holding firm for better rates in the wake of inflation and heavy catastrophe years. The reinsurance market was disciplined in holding its ground to achieve rate improvements given the lackluster performance and growing headwinds the sector is facing.

It was not just about pricing in this renewal cycle…

Along with pricing, reinsurers have tightened their underwriting standards and in some instances were willing to let go of business that didn't fit their new view of risk. Reinsurers are wary of increased frequency of natural catastrophe losses and secondary perils. As a result, they have adjusted their coverages, notching up their attachment points and showing less or no intent to write lower layers, and tightening policy wordings for clear exclusions for certain risks such as cyber, war, and terrorism. The structural changes that took place during the January renewals will be long lasting because it will be hard for reinsurers to move back on their new attachment points.

In addition, reinsurers have shown less appetite for aggregate covers, and instead have focused on per occurrence covers. Overall, reinsurers' revised risk appetite indicates a distinct shift toward taking on severity exposure rather than frequency.

Rising Cost Of Capital Is Adding To Reinsurers' Misery

Capital has experienced a shift since the beginning of 2022 when it was cheap and issuances were plentiful. Rising interest rates intended to battle inflation have stifled the capital markets, and the impact is felt beyond just the re/insurance industry. Interest rates severely affected re/insurers balance sheets with unrealized losses on bond portfolios chipping away at capitalization. Aon estimates that global reinsurance capital declined by 17%, or $115 billion, during the first nine months of 2022. However, a portion of the unrealized losses could recover over the next couple of years as these securities are held to maturity. In addition, expected improving underwriting earnings, increasing investment income, prudent capital management, and sophisticated levels of risk management should sustain the industry's capital adequacy. Speculation remains whether the rate improvements in the reinsurance markets will be enough to entice new capital into the space.

Chart 1

A barrage of above average catastrophe losses has battered insurance linked securities (ILS), raising doubts in investors' minds about the risk-adjusted returns of this sector and sponsors' risk-modeling capabilities. The influx of new capital was also constrained due to financial market volatility and deterioration in investors' assets under management from traditional asset classes. In addition, in a rising interest rate environment, other competing investment themes (distressed and high yield markets) seem to be more attractive relative to collateralized reinsurance.

We believe that investors will continue to favor catastrophe bonds because they have better structure, clear coverage, and liquidity compared with other ILS solutions such as collateralized reinsurance, sidecars, and industry loss warranties, resulting in more capital allocated to the catastrophe bond market. According to Aon, the total catastrophe bonds outstanding grew to $35.5 billion in 2022 and are likely to continue to grow.

Chart 2

The global reinsurance industry has a poor track record when it comes to earning its cost of capital. Since 2017, the industry has earned its cost of capital in only one year (2019), and we believe the sector again fell short in 2022. The industry's performance in 2022 was severely affected by Hurricane Ian which, according to Aon, is estimated to be a $50 billion to $55 billion event, the second-largest hurricane loss on record. 2022 is another year with above average catastrophe losses which, much the same as previous years, has undermined reinsurers' returns. Natural catastrophes continue to challenge the space and have largely been the motivation behind multiple years of rate increases with little chance of letting up. Now, as central banks hike interest rates to tame inflation, reinsurers' cost of capital is also rising--making it even harder for reinsurers to earn and exceed their cost of capital.

Chart 3

While reinsurers have no shortage of hurdles and uncertainties to overcome, the rate increases achieved during the January renewals and the underwriting actions taken are a positive sign that the industry may be rounding the corner.

Related Research

• Is The Global Reinsurance Sector About To Turn A Corner?, Sept. 6, 2022