For some time now, business and industry reports have been relating how pricing in many areas of the property catastrophe (re)insurance business are being forced down by a combination of the absence of major, industry-changing catastrophe events and the seemingly ever-increasing amount of alternative capital flowing into the industry. Individual companies have reported losses from particular events (such as European or Canadian floods, or US tornadoes), but there is an absence of “mega-CATs”. Of course, this is a good thing for Humanity, but in the face of issues such as climate change, the probability of more stringent capital requirements, and the low-return investment environment, it pays to step back and consider the potential consequences.
Firstly, are companies adapting (or not) to the rate environment; secondly, is that “adaptation” sustainable; and, thirdly, are there opportunities that exist outside the “NatCAT” arena to compensate?
On the first point, it seems obvious to us that we are in a Darwinian environment, where the strongest and most adaptive will survive; and the weaker, less adaptive will disappear, whether through consolidation or being forced to cease writing NatCAT business. It matters very much whether one is able to set prices and structure business, or whether one has become simply a price-taker, with a (not so) simple choice of putting one’s stamp down and hoping that things turn out well in order to generate at least some premium income, or refusing to do business at the price offered. So, the largest, best capitalized and most expert writers of NatCAT are beginning to differentiate themselves from the secondary markets.
On the second point, an interesting question arises, as to whether those who purchase NatCAT in an environment where competition and a surplus of capital are driving down rates seemingly relentlessly realize that it is actually in their own interests not to push matters too far; because, if the industry as a whole is unable to write business profitably or becomes concentrated into fewer, larger traditional providers, abetted by the notoriously fickle “alternative capital” providers, when the next “Big One” happens (as it surely will) they may find themselves at the mercy of a hardening market in which they are forced to accept extremely unpalatable price increases to obtain any cover at all. We are in no way advocating anything other than an open market, but the purchasers of protection need to think about outcomes and be careful of what they wish for.
So, the current situation and trends do beg the question of the point at which the rating environment becomes unsustainable, because, having competed on price and exposed their capital to losses for which they are not being properly compensated based upon historical experience and longer-term climatic trends, the remaining participants themselves become vulnerable to the impact of a mega-CAT; having been beguiled by the thought that they are one of the “survivors”.
What then, is a (re)insurer to do to restore or replace its premium flows from other sources? We at Awbury would suggest that they take a closer look at the FinCAT market, where we believe there are many opportunities arising from an increasingly harsh, complex and irrational regulatory environment for both banks and NBFIs, as well as from situations in which pricing available is not properly correlated with the underlying risk; and, therefore, offers a superior risk/reward outcome.
-The Awbury Team