According to analysts at Fitch Ratings, changes to reinsurance-related capital requirements proposed by the Australian Prudential Regulation Authority (APRA) could wind up supporting Australian general insurers’ credit profiles over the medium term if they improve access to reinsurance protection.
But, the agency notes, that catastrophe reinsurance pricing and the frequency, severity and cost of natural disasters will remain important factors in regards to determining insurers’ willingness to take on reinsurance, and ultimately the long-term effect on their capital and earnings.
For those unaware, APRA launched consultations on planned reforms that would require general insurers to buy all-perils reinsurance coverage, while lowering reinstatement requirements and removing the requirement to hold reinstatement premiums as part of the insurance concentration risk charge (ICRC).
From what we understand, any new standards are not set to come into effect until June 2026.
According to Fitch, the initiative may be designed partly to encourage insurers to explore further alternative reinsurance arrangements, including catastrophe bonds and other insurance-linked securities (ILS).
It’s worth highlighting, that take-up for alternative reinsurance arrangements has been limited so far in Australia, despite a burgeoning global market. However, the agency noted that this may partly reflect the current regulations around reinstatement requirements for catastrophe reinsurance.
Alternative reinsurance structures usually do not have such reinstatements, therefore meaning that the APRA’s proposed lowering of reinstatement requirements could be favourable for this part of the sector.
“We believe rising catastrophe reinsurance costs have contributed to insurers’ raising of their retention limits, increasing the exposure of their earnings and capital to such risk. Suncorp Group Limited, for example, raised net retention under its main catastrophe reinsurance cover for the financial year ending June 2024, from AUD250 million to AUD350 million. It also opted not to renew its aggregate excess of loss reinsurance, a type of cover offering protection after an accumulation of smaller events,” Fitch commented.
Furthermore, the rise in catastrophe reinsurance costs has been driven mainly by the increased frequency and severity of extreme weather events, which has remained a key subject across the reinsurance industry.
Analysts also stated that regulatory adjustments alone may be insufficient to reduce reinsurance costs if catastrophe losses borne by reinsurers continue to escalate.
Adding: “Insurers’ usage of reinsurance is also influenced by factors such as internal risk appetite and rating agency capital considerations. Where these are the main driver of how much catastrophe risk is retained, APRA’s proposals may have less effect on retention rates.”
The agency also went on to note how more reinsurance options would give insurers greater scope to manage their net exposure without majorly increasing net retentions and probable maximum loss (PML) values. As a result, this would support insurers’ credit profiles by helping them maintain net catastrophe exposure within manageable levels.
“Insurers could face a greater risk of negative capital and earnings effects if there are successive severe catastrophes (such as one-in-200-year losses), and they are not covered via reinstatements. We believe this risk remains low. Such events should be extremely rare, though the changing frequency and severity of natural disasters underlines uncertainty over this assumption,” Fitch concluded.
