Analysts at BMO Capital Markets anticipate +30-40% reinsurance pricing-power increases at the mid-year Florida renewals, compared to reinsurance pricing of +28-38% at Jan 1.
According to BMO’s analysts, Terms & Conditions remain “as tight as can be”, meaning reinsurers will be “on the hook” for meaningfully less market share of overall catastrophe losses in 2023 compared to prior years.
Some of BMO’s examples include higher deductibles, as well as only specific named storms versus all hurricanes, shorter timeframes for claim notifications, and deeper modelling/harder looks at property replacement cost inflation assumptions.
Another example is coverage based on market share within a specific geography versus the insurer’s specific losses, which BMO suggests would negatively impact insurers with poorer claims practices.
Elsewhere, the firm notes that retro reinsurance capacity is starting to increase but similar to traditional reinsurance, at much tighter terms & conditions.
BMO writes, “Retro is an enabler for reinsurers. For every $1 of retro, approximately ~$4 of reinsurance can be written. That rule of thumb might not be the case today given tighter terms and more uncertainty over retro being available in subsequent years.”
The firm continues, “Given both BMO Research and the stock market predict higher reinsurance costs will be sustained through 2023, we believe investors, some of whom have rotated into insurance as a “safe haven” in recent quarters, should be aware that the near-term risk/reward equation for insurance carriers who are overly reliant on reinsurance protection is now skewed towards profit margin risk, in our view.”
Reinsurance valuations continue to reflect “boom times” explains BMO, trading meaningfully (+30%) above historical book value levels given elevated hard-market return on equity expectations.
The firm adds, “Despite our now deeper appreciation for the current “hard market” pricing power marketplace, which we estimate will begin to decelerate in 2024, we prefer not to chase reinsurance stocks and maintain Market Perform ratings on the group.
“Why? Barriers to entry within the reinsurance space are relatively low, EPS volatility is inherently high, and we estimate capital will continue to flow into the space, reducing RoE levels back into the ~mid-teens by 2025.”
For primary-centric insurers that account for most of the U.S. publicly traded insurance market cap, the firm continues to estimate the potential for negative surprises arising from meaningfully higher property-replacement cost inflation (i.e., wage and input inflation over the past three years has been upwards of 25% cumulatively), combined with higher property & casualty reinsurance costs.
Though, BMO does highlight that these meaningfully higher costs may take many years to be fully appreciated by investors.
For example, the firm says that more stringent reinsurance policy terms & conditions are becoming the norm, forcing primary insurers to raise their retention/deductibles/skin-in-the-game levels.
This will result in higher catastrophe levels for primary insurers, which should take time for investors to fully appreciate given catastrophe levels are measured over many years versus quarters.
BMO concludes, “It’s notable that reinsurers came away from 1Q23’s heightened U.S. catastrophe season unscathed while primary insurers exhibited worse than expected loss levels.”
