In a challenging market environment, the reinsurance industry is grappling with significant hurdles as catastrophe losses surge and the reliance on external capital becomes increasingly vulnerable, according to Swiss Re’s report titled “The State of the Reinsurance Property Catastrophe market.”
Over the past two decades, low interest rates have fueled a greater appetite for risk in financial markets, leading to a substantial portion of capital supporting catastrophe risk being sourced from alternative markets such as cat bonds and insurance-linked securities.
Swiss Re revealed that insured losses from natural disasters reached a staggering $125 billion in 2022, marking the fourth-highest year for insured losses on record. The figures were eclipsed only by the losses in 2005, 2011, and 2017.
Traditionally, the reinsurance market relied on a self-supported funding model. However, with the increased involvement of external capital, reinsurers’ balance sheets have become highly leveraged, leaving them susceptible to short-term capital flows.
This shift has transformed the industry, making it heavily reliant on the availability of external capital leverage, thereby creating risks and challenges.
The reinsurance sector has experienced a fundamental change, where retained earnings have proven insufficient to cover the cost of capital, let alone strengthen balance sheets to handle an expanding risk landscape.
Since 2017, weather-related natural catastrophes have cost the re/insurance industry a staggering $650 billion (in 2022 prices) in claims.
Unfortunately, premium income has failed to keep pace with the increasing frequency and severity of these events, resulting in declining profits for the industry.
Natural catastrophe losses have a direct impact on industry capacity, reducing profitability and capital supply. These losses also influence re/insurers and investors to reassess their risk evaluations. The concern over whether risks are adequately priced affects the supply of capital and the capacity available for underwriting.
The surge in catastrophe and claims activity since 2017 has raised doubts among re/insurers and investors, leading to a slowdown in the supply of capital. As a consequence, leveraged positions are unwinding in the face of record losses from secondary perils and an unprecedented surge in inflation, which has reached a 40-year high.
Secondary perils, such as weather-related catastrophes, have caused losses that deviate significantly from traditional industry loss models. The magnitude of these losses between 1970 and 2022 is evident, reflecting the challenges faced by the re/insurance industry in managing such events.
Uncertainties surrounding modeling discipline and the adequacy of premium levels to address increasing loss costs and emerging secondary perils have also dampened providers’ risk appetite.
Compounding these challenges is the protracted soft market experienced by the reinsurance industry, stemming from historically positive results. This allowed primary insurers to become heavily leveraged to reinsurance protection at low attaching levels.
As the balance of risk shifted between insurers and reinsurers, the insurance market became increasingly reliant on the reinsurance market, which, in turn, became dependent on the capital markets.
The beginning of this decade brought further strain as reinsurers faced systemic and macroeconomic risks that had not been adequately priced, starting with the COVID-19 pandemic and its related business interruption losses.
Subsequently, the impacts of the Ukraine war and an ongoing inflation shock exacerbated the pressure. Swiss Re economists predict that higher inflation will persist in 2023 and beyond.