Until recently, the term “loss creep” was not one much heard publicly in (re)insurance circles. Reserve releases were generally the order of the day, and useful for primping Combined Ratios for public consumption.
Now, however, the phrase has become almost a trope, as increasing estimates for the overall claims cost of a greater number of major CATs (think of 2018’s Typhoon Jebi as the current “poster child”) mean that (re)insurers not only have to worry about increasing their reserves, but also about the risk of blowing through their retro covers. And just think what specialized writers of retro CAT must be feeling!
Such events are a further sign that, in the commoditized world of CAT, the “old certainties” need re-thinking. Hitherto “conservative” assumptions are now revealed as no longer fit for purpose. All this means that rather than being as equally wrong as everyone else, underwriters (and their CAT-modelling colleagues) are going to need to re-think their assumptions about what a “1-in-x” year event might look like, both in terms of frequency and then scale. Relying upon prior “industry standard” models, or estimates could become rather damaging to (re)insurers’ crucial reserve management methodologies, and ultimately to solvency levels.
Of course, this is likely to lead to executive managements wondering where they can look to assuage the pain of regularly missed “target” or “normalized” Combined Ratios. And what exactly is an appropriate “attritional” CAT Loss ratio or “budget” anymore?
Another phrase that is also becoming more prevalent is “closing the gap” when speaking about the availability of insurance coverage for natural disasters, particularly in so-called emerging markets. Given the demonstrated difference between economic and insured losses depending upon jurisdiction, and the continuing shift in the rate of economic growth away from developed markets, it is not surprising that a CEO looking for premium flow would be attracted to the idea of expanding into new geographic markets and helping to close the gap in coverage. However, one wonders whether a sufficient level of skepticism and true conservatism will be employed in the process of deciding to expand coverage into new jurisdictions. One can imagine the temptation to argue by analogy with existing developed markets that the same assumptions and criteria can be used. Yet if, in developed markets, the existing models are being demonstrated to be no longer fit for purpose, what can make a (re)insurer’s Board comfortable that somehow the process will be easier or more accurate in a new market?
We are not saying that entering new markets is misguided; simply that current experience in supposedly well-known and hitherto understood developed markets should give pause for thought before blithely entering new ones, especially if, as is often the case, everyone thinks the same thing at the same time. It may sound absurd, but could “closing the gap” become the classic “crowded trade”, whereas the smart money re-engineers its processes and increases discipline in markets in which it has long experience?
At Awbury, we believe strongly in focusing on the area- credit/economic/financial risks- in which we have a demonstrable and defensible track record. We adapt as markets and risks change, but we know that there are realistic boundaries to the scale and probability of losses that may occur, and that careful structuring can significantly mitigate risk of loss. Contrast that with the CAT environment, in which the probability of full-limit losses is all too real, especially in a world beset by increasing loss creep.
The Awbury Team