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Portfolio optimisation needed as market volatility rises: Guy Carpenter

12th September 2018 - Author: Matt Sheehan

Optimised portfolio construction is becoming an increasingly vital strategy for re/insurers to tackle growing market volatility, which is being driven by excess capacity and rising claim costs, according to Guy Carpenter, the reinsurance broker and wholly owned subsidiary of Marsh and McLennan Companies.

guy carpenterA global roundtable of Guy Carpenter leaders agreed that re/insurers’ earnings and capital are being impacted by a movement towards balance sheet volatility, caused by excess capacity and increasingly frequent and severe claims.

With abundant capital levels already putting downward pressure on underwriting profitability, in-flows of new capital continue at record levels, the panellists explained.

“Capital markets investors continue to flock to the sector following the loss events of 2017. Alternative capital, which rose to 20 percent of total dedicated reinsurance capital at year-end 2017 according to Guy Carpenter, paid losses as expected,” said Jay Dhru, Global Head of Business Intelligence at Guy Carpenter.

“Lost capacity was quickly restored, demonstrating investors’ commitment to the asset class and proving its reliability. Questions remain on the long-term impact of alternative capital on the competitive position of insurers.”

Guy Carpenter also noted that insurers are seeing positive earnings growth following a ten-year run of lower than normal catastrophe activity, further buoyed by prior-period reserve releases.

“Insurers may have been over-relying on reserve releases, so caution is needed in an environment of rising loss costs and expenses that consume an ever larger portion of reserves,” explained Matthew Day, Managing Director.

At the same time, the accumulation of reserve risk from long-tail lines and the impact of inflation on prior years is a material threat to financial results and contributes to volatility, the roundtable agreed.

Some companies may be pressured to reserve to their ‘base case’ or less because of competition, with others holding back on releases in case trends worsen or because their reserve cushions are shrinking.

“Increasing cost of claims coupled with a rapid rise of severity contributes to balance sheet volatility, raising the possibility that excess capital may in fact not be at ‘excess levels,’” said Jack Snyder, Managing Director, Ratings Advisory.

“Increases in severity in 2017/2018 contributed to continued unprofitable underwriting results in liability lines across medical, commercial auto and other liability occurrence. The rise in severity is likely to endure and can no longer be treated as one-off events.”

“The increase in large jury awards also influences growing claim severity with a risk of a concomitant increase in frequency,” Snyder continued. “Increasing rates of inflation may also grow claims costs, further burdening balance sheets.”

Additionally, more intense weather patterns may be contributing to the uptick in frequency and severity, while loss costs are rising faster than rates, meaning earnings do not exceed the cost of capital on a normalised basis for reserves and catastrophes.

“There are solutions for (re)insurers that turn these challenges into opportunities,” added Snyder. “A strategy that optimizes portfolio construction is just as important as upfront underwriting of a risk.”

The roundtable concluded that the use of new capabilities built on sophisticated data analysis, in combination with reinsurance solutions, is critical to continued growth and strategic capital management.

“These solutions offer greater certainty in financial results, enhancing companies’ long-term earnings and opportunities for profitable growth,” said Dhru.

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