An unusual combination of factors has refocused the non-life reinsurance sector. Yiannis Parizas asks chief underwriter Michael Hinz to reflect on January’s renewal and assess the shape of things to come
What’s your background in the industry?
I started as a reinsurance apprentice at Munich Re in Munich in 1993. I then studied insurance business management at the Deutsche Versicherungsakademie and worked towards my Fellowship accreditation at the Chartered Insurance Institute.
I worked at Munich Re in various technical underwriting and client management roles until 2012. Apart from my day job, I had the chance to lead a global ‘expert line of business’ network for marine reinsurance and political risks, as well as a global actuarial network for proportional treaty pricing.
Between 2005 and 2008, I headed the corporate actuarial and underwriting services department in Johannesburg, raising technical underwriting standards and representing the company to various market bodies and associations in Sub-Saharan Africa. I was also responsible for establishing the local pricing and reserving function. On returning to Munich, I led the marine team for Europe and Latin America from 2008, and served on the group’s Global Marine Board.
In 2012, I joined Tokio Millennium Re (a subsidiary of Tokio Marine) in Zurich to see the industry from a different angle and set up a branch office. I then started to lead the underwriting and operations departments of the company’s Swiss entity, which by then had become the group’s head office. From 2016 to 2019, I led Swiss Re’s casualty department for north-eastern Europe and steered the EMEA motor portfolio with a group of people from the risk management, reserving and underwriting functions. That role also involved quality assuring the parametrisation of long-tail pricing assumptions.
I then joined Korean Re Switzerland, a Korean Re subsidiary that is regulated by the Swiss Financial Market Supervisory Authority, as its chief underwriting officer and member of the Swiss executive management team. My role here has been to establish and develop Korean Re’s European hub for non-life treaty business. The main priorities have been developing the pricing and analytics function and our footprint and value proposition to the European markets, as well as contributing to the strengthening of the group’s global underwriting, pricing and risk management expertise.
The January renewal was extraordinary in terms of the market hardening. How did the property and casualty (P&C) reinsurance market change?
The last renewal was characterised by strong, broadly applied underwriting discipline from most reinsurers, sufficient European natural catastrophe (natcat) per event capacity, and reduced aggregate excess-of-loss capacity. Reinsurers insisted on improved event definitions, transparency around inflation’s impact on reinsured portfolios, and higher attachment points, paid instead of so-called prepaid reinstatements. Some companies reduced European windstorm exposures and aimed to diversify their portfolios into casualty and speciality lines, or earthquake in Southern Europe as peril zone.
For the US, catastrophe risk capacity became scarce and, to our understanding, not all placements were completed. The contracting retrocession market impacted some reinsurers that were over-reliant on retrocession capacity, as they could not start the renewal before securing capacity.
P&C market prices increased significantly across the globe to an extent not seen for decades. Short-tail rates increased more than those for long-tail business because inflation affected the on-levelled exposures immediately and more tangibly.
For long-tail business, the market reaction was more differentiated and not unanimous. This is because reinsurers were working with different assumptions on how long we will live in an elevated inflation environment, and to what extent and when interest rates can offset the inflationary trend.
Where insurers applied or adjusted features to mitigate inflation in commercial or industrial business, the inflation risk seems to have been well managed and to have caused less volatility to their proportional reinsurers. Examples in casualty include policies that adjust premiums according to the policyholder’s turnover. In property and engineering, insurers and policyholders updated sums insured. Insurers also applied policy features such as average clauses, business interruption (BI) volatility clauses or sub-limits for BI, and increased deductibles or franchises more strictly and consistently.
In motor, original tariffs often did not keep pace with the increased inflation on spare parts. Insurers also relied too much on 2020 and 2021’s good results due to Covid-related lower attritional loss frequencies then, which covered underlying inflationary trends.
In fire, we saw a concerning broad change in the severity and frequency of large man-made losses, which forced reinsurers to understand changes to reinsured portfolios and underlying loss drivers.
What caused the hardening of the market?
The reinsurance market has been forced to return to sound underwriting basics for several reasons. The first is that returns on capital have been relatively poor for several years across the industry. It has become clear that higher technical profit margins are needed to maintain investor confidence. In addition, poor technical performance coincided with a sharp rise in interest rates in 2022, leading to massive capital erosion due to mark-to-market losses on the asset side.
Second, Covid proved the industry had covered systemic risks that had not been well understood or perceived as a real threat.
Third, climate change’s effects on underwriting performance have become visible in western Europe, turning so-called secondary perils into unprecedented major events such as Flood ‘Bernd’ in Europe in 2021, a series of hailstorms in France in 2022, and several years in which freeze and drought caused major losses to European agriculture markets and French property business. These events were followed by Hurricane Ian, one of the most violent hurricanes on US record.
Fourth, reinsurers saw diminishing reserve redundancies, lower and riskier investment returns, and a continuous increase in non-natcat losses: ongoing supply chain disruptions have caused the proportion of BI versus material damage losses to shift significantly towards BI loss components, and increased the overall loss burden. Cyber ransom losses have risen rapidly since 2019 and raised awareness for the dynamically changing nature of the risk, which has increased further since Russia invaded Ukraine and state-backed attacks have become a reality. In addition, aviation and composite political risks products have caused major headaches to global speciality markets such as Lloyd’s.
Finally, it is a paradox that rising interest rates, which provide higher future investment returns, have led to a reduction in accounted capital. Most rating agencies’ models are based on accounted capital, so internal and regulatory economic steering models have somewhat reached their limits, especially for reinsurers whose mostly unrealised investment losses have reduced accounting capital to levels that could result in a lower rating in future.
What this market hardening has in common with other periods of global hardening is that there has been substantial pressure on both sides of the balance sheet, accompanied by increasing geopolitical and economic uncertainty.
Are you expecting the market to harden more in future renewals?
I expect it to continue for some time, but at a slower pace. Chief financial and underwriting officers need to prove to capital providers that they can achieve levels of profitability that make reinsurance more attractive than the investment alternatives. And with AAA-rated government bonds yielding coupons of 4% and more, reinsurers need to show sound double-digit returns.
In addition, one or two years of better results are clearly not enough to restore investors’ confidence in the sector’s long-term ability to provide adequate returns. For now, we can say that no significant new capital has been invested in reinsurance since 2022, and alternative capital has not increased since around 2017.
I think alternative capital will play a smaller role in the future, as investors have attractive alternatives in the bond market that are more transparent and better understood than natural perils and global warming, which are inherent to catastrophe bonds.
Was the higher number of property catastrophe claims in Europe in recent years a coincidence, or is it a new norm?
When looking at the average temperature’s deviation from the norm in Europe, we can see a linear trend from around 1920 to 1980. This accelerated until 2010, with a further acceleration thereafter – suggesting a new and further aggravating norm.
Given that Europe has been warming at twice the pace of the global average in recent years, I expect it will continue to see more frequent and more severe natcat events than it has experienced in the past decade. Natcat risk will pose challenges to public infrastructure, city and agglomeration planning, building codes and permissions, traffic and transport, consumption of resources and agriculture, and risk financing in the private and public sector.
We expect that volatility will continue to increase, and believe the insurance industry has a relevant role to play in managing technological and societal changes as we move towards a net-zero society, as well as in supporting a resilient economic transition.
The next few years will also pose questions for underwriters over what terms and for what perils natcat will remain insurable. Scientists and underwriters need to understand whether and how to manage global diversification concerning global warming-related perils – especially considering that the five hottest years on record have all happened since 2016 and that the past eight years were the warmest eight in history, according to the EU’s Copernicus Climate Change Service.
Central banks have used interest rate increases to control inflation. How did this impact the renewal?
It affected the industry in terms of assets and liabilities. On the liability side, firstly, inflation needs to be priced in using sound on-levelling techniques. Secondly, cashflow has become more important when evaluating a treaty’s present value. Interest rates have historically been higher than inflation rates, but the opposite has been the case in the recent past – which has implications for pricing when analysing cash inflows (premium) versus cash outflows (losses).
On the asset side, the reduction of accounted capital created pressure, despite increasing investment returns, for the reasons described above.
It is widely acknowledged that IFRS 17 will impact P&C less than life insurance – but what do you think?
We welcome the convergence of accounting and pricing principles through IFRS 17 implementation. It will lead to more consistent market value-oriented views and better communication between reporting functions, pricing and underwriting. For reinsurance buyers, it is vital to understand the impact of market-consistent valuation concepts on their reinsurance purchasing decisions. We think this has an impact on the amount of reinsurance purchase, as well as our clients’ reinsurance structures.
Michael Hinz is the chief underwriting officer at Korean Re Switzerland
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