JLT Re VIEWPOINT. Winds of change

Transcription

1 JLT Re VIEWPOINT Winds of change

2 CONTENTS SECTION 1: WHEN THE WIND BLOWS...4 SECTION 2: CLEARING THE HAZE...10 SECTION 3: THE LONG VIEW...16 At JLT Re, our trusted team combines market-leading expertise and proprietary analytical tools with the freedom to challenge conventions. We create new insights and explore innovative capital solutions tailored to meet client needs. TOGETHER, WE DELIVER RESULTS

3 3 EXECUTIVE SUMMARY After five years of below-average loss experiences, 2017 looks set to become the most expensive catastrophe loss year ever for the P&C sector. The vast majority of these losses are down to the hyperactive 2017 hurricane season which has, to date, dealt a devastating triple blow to residents and businesses in the United States and Caribbean in the form of hurricanes Harvey, Irma and Maria (HIM). Prior to this year s hurricane season, no major hurricane had made landfall in the United States since Wilma in That extraordinary run of good fortune ended abruptly when Harvey and Irma caused widespread devastation after coming ashore in Texas and Florida, respectively, as category 4 storms. Extreme and prolonged rainfall accompanied Harvey s landfall whilst Irma was more of a conventional wind and surge event as it moved up Florida s west coast. Maria followed soon after, cutting a destructive path through parts of the Caribbean (Puerto Rico in particular) to produce one of the market s most expensive natural catastrophes ever outside the US mainland. The events of 2017 therefore look set to rank alongside other market-defining catastrophes. But following several years of low loss activity and sustained capital inflows, the reinsurance market faces this new market environment from a position of strength. Indeed, sector capital was at record levels heading into the 2017 hurricane season, which translated into at least USD 60 billion of excess capital. And losses so far this year have fallen within modelled expectations the sector is well prepared for three landfalling hurricanes in the world s most comprehensively analysed peak risk region. This report assesses how the events of 2017 are likely to impact the reinsurance market and provides historical context to highlight key differences that exist today with previous market-changing events. As things stand, JLT Re believes that the nature of the losses in 2017, and the sector s existing capital buffer, will prevent a repeat of the market reaction that followed the 9/11 attacks in 2001 and Katrina in There was an element of the unexpected with both of these events and it must be remembered that the sector s capital position was lower and less resilient during these years as it respectively entered and exited the liability crisis. This is not to say consequences will not be felt. Harvey, Irma and Maria alone are expected to cost carriers up to USD 100 billion. Reinsurers and insurance-linked securities (ILS) investors are on the hook for a substantial portion of this total due to Florida being a heavily reinsured market and several insurers in the Caribbean having modest retentions. Retrocessionaires are likely to suffer particularly significant losses, given several reinsurers have taken advantage of competitive market conditions to obtain broader or additional protection in recent years. All this has reset expectations heading into the 1 January renewal. For the first time since 2012, upward pricing pressures are likely to build in property-catastrophe lines, particularly in loss-affected regions. But given that average global property-catastrophe rates have fallen by approximately 33% during this time, any increase is only likely to offset this reduction partially. In addition, the length of any market hardening could be mitigated by additional new capital flowing into the sector seeking yield post-event. Perhaps a more permanent feature in the post-2017 environment will centre on risk perceptions and higher loss expectations for future years. Growing demand for additional reinsurance protection is already evident and JLT Re is committed to obtaining the best cover and structures available to clients in this new market environment.

4 4 SECTION 1: WHEN THE WIND BLOWS Prior to this year s hurricane season, the reinsurance sector was seen to be in a state of static malaise. The backdrop was familiar to any seasoned market professional: fast-flowing capital inflows, excess capacity, stagnant premium growth and low loss experiences had coalesced to bring rates down to levels not seen since the turn of the century for most lines of business. At the same time, several cedents, encouraged by the sustained period of unusually low loss activity, sought to rationalise their reinsurance purchases in the hope of gaining efficiencies and more favourable terms. Irma passes through the Caribbean, coastline of Grand Cayman. Compressed underwriting margins, along with historically low investment yields, combined to create a perfect storm for reinsurers, with many firms struggling to generate returns above their cost of capital. Parallels with the last soft market in the late 1990s were inevitably drawn, prompting much debate over what it would take to precipitate a turn. A few even argued that the traditional market cycle was at an end due to changes in the sector s capital structure. SOFTENING OF THE SOFTENING But as JLT Re observed back in 2015 in its Change in the air? Viewpoint report, evidence of cyclical shifts remained as the market continued to evolve during this time. Whilst the supply glut remained the dominant market force, factors such as slowing entry rates for alternative capital, reinsurer mergers and acquisitions (M&A), increasing cessions at the margin and reserving volatility provided important counterweights and coalesced in moderating price declines. This first manifested itself during the mid-year renewal season of 2015, when these changing market drivers led rate reductions to slow for the first time in three years. This softening of the softening trend has characterised the market since. Figure 1 shows how the overriding shift to single-digit reductions became more pronounced in subsequent years (2017 in particular). WAKE-UP CALL Expectations for 2018 were for more of the same i.e. a softening, but moderating market. But then the 2017 hurricane season happened, bringing three massive hurricane strikes to US territories and causing widespread devastation across the Caribbean as hurricanes Harvey, Irma and Maria formed in quick succession. Nate followed in early October, adding to carriers loss burden after it hit Louisiana and Mississippi as a

5 5 Figure 1: Average Rate Movements by Line of Business at 1 January Renewal 2016 and 2017 PROPERTY & CASUALTY US Property-Cat Western Europe Property-Cat Asia Pacific Property-Cat Middle East Property-Cat London Market Global Property Retrocession Property-Cat Industry Loss Warranties US Public Entity US Workers Compensation London Market Casualty Western Europe GTPL Western Europe Motor Middle East Motor SPECIALTY Aviation Marine & Energy Terrorism Cyber -25% -20% -15% -10% -5% 0% 5% category 1 storm. As a result, 2017 looks set to challenge 2005 to become the most expensive hurricane season ever. And it will be only the third year on record in which global insured catastrophe losses have exceeded USD 100 billion (along with 2005 and 2011). From an insurance perspective, Harvey was a very different storm to Irma and Maria, bringing its own, unique destructive characteristics to Average rate change % (loss - -free) (Source: JLT Re) communities in Texas. Despite being a powerful category 4 hurricane when it came ashore, Harvey was mainly a flooding event for the sector, dropping more than 50 inches of rainfall in parts of the state and triggering one of the biggest insured motor losses ever. Houston took the brunt of the flooding, causing substantial damage to commercial properties concentrated in the city (in addition to the motor claims). This, in turn, caused significant revenue losses across several subsectors and led to supply chain disruption for a number of businesses. Given Harvey s unique loss profile, the majority of claims are expected to be retained by the primary market. Irma and Maria were more conventional wind and surge events, and their impacts, including those of Harvey, are likely to rival Katrina, Rita and Wilma in 2005 as being the biggest combined reinsured catastrophe loss recorded in a single year. After Irma took a destructive path through the Caribbean, where it caused human devastation, tens of billions of dollars of economic losses and billions in insured damage across several islands, the storm turned towards Florida, threatening a worst case scenario for the sector as model guidance pointed towards a direct hit in the tri-county area as a category 5 hurricane. Insured loss estimates of USD 100 billion or even USD 200 billion were widely cited amidst fears of company insolvencies and widespread distress. In the end, a late shift in Irma s path as it exited Cuba meant the sector avoided the worst, with the storm moving away from Miami and passing over the Florida Keys as a category 4 hurricane, before making a second landfall at Marco Island as a weakened category 3 storm. Yet, although Irma s late deviation west

6 6 prevented a triple-digit billion loss, it will still be one for the market s archives as it looks set to become one the most expensive (re)insured losses in history. But, if some estimates are to be believed, Irma s impact on the market could yet be eclipsed by Maria after it directly hit Puerto Rico and several other islands in the Caribbean (some of which had already been ravaged by Irma a couple of weeks before) as a category 4/5 hurricane. Maria obliterated buildings in Puerto Rico and knocked out power across the entire island, generating major business interruption losses from high-value assets in the manufacturing (pharmaceutical) and tourism sectors in particular. Higher insurance penetration in the US territory (compared to elsewhere in the Caribbean) and uncertainty over take-up rates have meant some loss estimates for Maria have risen well above initial market expectations. OUTSIZED REINSURED LOSSES Figure 2 shows that Irma s costs to reinsurance carriers could challenge, or even surpass, those of the 9/11 attacks or Katrina. This reflects the unique nature of the Florida homeowners market, where local property insurers now dominate market share having formed in recent years to take risk from state-run Citizens. Prior to Citizens, a number of national carriers pared back their Florida market activity in the early 2000s following a period of severe weather events. Irma therefore represents the first major hurricane landfall for most of these pure-play Figure 2: (Re)insured Losses Following Major Catastrophes 1 USD billion (inflation-adjusted) Hugo (1989) Andrew (1992) 9/11 attacks (2001) 2004 hurricanes Insured loss Katrina (2005) Ike (2008) Reinsured loss Harvey (2017) E Irma (2017) E Maria (2017) E (Source: JLT Re, Insurance Information Institute, Swiss Re, Wharton Risk Center, Disaster Insurance Project) Florida carriers (Wilma was the last major hurricane to hit Florida in 2005). Crucially, they typically buy high levels of reinsurance protection that trigger at low attachment points, meaning reinsurers are likely to take an outsized percentage of the total loss compared to other major hurricane events. All these relatively thinly capitalised carriers are required by rating agencies to buy reinsurance protection to cover at least a 1-in-100-year return period probable maximum loss. And whilst larger national and regional carriers typically have higher retention levels than their domestic Florida counterparts, significant levels of loss are still likely to be ceded to reinsurers. So, despite lingering uncertainty over the final tally, Irma is clearly going to be a historical loss to the reinsurance and ILS markets. Global reinsurers are also likely to absorb a significant proportion of the losses from Maria, as Puerto Rico s domestic personal lines carriers have significant reinsurance coverage. Major commercial reinsured losses are also expected. Traditional reinsurers dominate programmes in the islands impacted by Maria, although some ILS and collateralised markets are also likely to be exposed. RIPPLE EFFECTS Whilst this year s hurricanes are certain to be complicated events (demand surge could be an especially significant factor given the severity of damage and widespread nature of loss geographically), insured catastrophe losses at the end of Q were already approaching USD 130 billion (see Figure 3). Assuming Q4 will add another USD 5 billion to USD 10 billion of insured catastrophe losses (which is consistent with recent years and perhaps conservative given the wildfires in California), the full year total looks set to become the most expensive catastrophe loss year ever for the P&C sector. 1 Insured losses (recorded and estimated) for hurricanes exclude National Flood Insurance Program (NFIP) claims.

7 7 Figure 3: Global Insured Catastrophe Losses 1970 to Q USD billion (inflation-adjusted) Q3 2017E Seismic Meteorological Man-made 10-year moving average Number of events (RHS) (Source: JLT Re, Swiss Re) has therefore brought a decisive end to a five-year period of below-average global catastrophe losses. This is important for three key reasons: 1. Costly natural or man-made catastrophes have historically had a significant bearing on reinsurance rates, particularly for propertycatastrophe business (see Figure 4, page 8). Given that the combined loss total for Harvey, Irma and Maria is expected to erode reinsurers catastrophe budgets, hit earnings and even absorb a portion of the excess capital in the market, some impact on property-catastrophe pricing is likely. That said, any potential pricing increase may be muted compared to those in the 1990s and early-tomid 2000s due to the sector s strong 2 Includes NFIP insured losses. capital position and expectations that losses from these three hurricanes will fall within modelled parameters (more on all this later). 2. Low loss activity since 2012 has been one of the key contributors to the sustained soft market environment. These light catastrophe years have flattered reinsurers results and added to the build-up of sector capital. With a number of reinsurers already struggling to generate returns above their cost of capital in a low loss environment, any further deterioration in loss experiences will seriously challenge profitability. 3. The recent spike in loss activity is likely to change perceptions of risk and the overall mindset of the market. After years of subdued losses, the catastrophes of 2017 could encourage carriers to assume higher loss experiences in future years, instead of relying on good fortune to persist indefinitely. Irma showed that a USD 100 billion or USD 200 billion loss involving a major hurricane hitting a metropolitan area is not only the domain of Hollywood, but a reality that requires serious consideration and risk mitigation action. Maria also surprised many by causing tens of billions of insured damage without making landfall on the US mainland. In fact, both Irma and Maria generated interest in back-up cover, suggesting some cedents recognise that they are over-exposed and under-reinsured for such outcomes. It is therefore hardly surprising that some carriers have sought additional reinsurance protection for the remainder of 2017.

8 8 Figure 4: JLT Re s Risk-Adjusted Global Property-Catastrophe Rate-on-Line (ROL) Index 1992 to USD billion (inflation-adjusted) Andrew % 42% Andrew (1992) Figure 5: Protection Gap for Significant US Losses 33% 67% 1999 Katrina (2005) / % 53% Hurrican Wilma (2005) 2003 Katrina % 67% Ike (2008) Losses not covered by private market Ike % 73% 2010 Superstorm Sandy (2012) 2011 losses* * Including Christchurch earthquake, Tohoku earthquake, US tornadoes and Thai floods. US PROTECTION GAP EXPOSED As an aside to the last point, the US Government may also consider transferring more flood risk into the reinsurance market following the devastating flooding and storm surge that Harvey and Irma brought to communities in Texas and Florida Private market losses 28% 72% Sandy 2013 Harvey (2017) E % 53% 2017 (Source: JLT Re) Figure 5 provides a breakdown of losses for recent US hurricanes between those covered by the private (re)insurance market and those that are not. Despite the rhetoric of recent years from market participants about narrowing the difference between insured and economic losses, Figure 5 shows that the protection gap, for US hurricanes at least, is heading in Irma (2017) E (Source: JLT Re, Bloomberg, Munich Re, RMS) the wrong direction. Strikingly, only a quarter of Harvey s total economic loss is thought to be insured by private carriers. Or to put it another way, the financial cost of recovery will mostly fall to US taxpayers rather than the well-capitalised (re)insurance sector. Interestingly, the protection gap for Maria is currently projected to be less than that for both Harvey and Irma, although underinsurance remains a problem elsewhere in the Caribbean. Much of the gap in the US can be attributed to the lack of flood and surge cover on offer in the private market, with the federally-backed National Flood Insurance Program (NFIP) currently being the go-to carrier for the relatively small number of US homeowners and small businesses that purchase flood protection. Some estimates indicate that total residential flood losses from Harvey could reach up to USD 37 billion, with roughly USD 11 billion thought to be covered by the NFIP and very little falling to private (re)insurers. And whilst flood risk is often included within some commercial policies provided by the private market, it is typically subject to varying degrees of limits and sub-limits and take-up is often restricted to larger corporations. There is clearly scope for the private market to take on a greater proportion of US flood risk than it does presently. At a minimum, this could take the form of an extended reinsurance programme. But given that the NFIP was almost USD 25 billion in debt to the US Treasury even before Harvey and Irma occurred, more radical solutions could ensue, particularly as

9 9 Congress debates its renewal this year (the programme is currently set to expire in December). Either way, increased participation in the US flood market by (re)insurers represents a significant opportunity for the sector as it will enable it to deploy some of the excess capital in the market. And this applies globally, with the protection gap continuing to widen in many parts of the world. LIFE AFTER HIM After years of stagnation, the reinsurance market has seen a flurry of activity in recent months. As attention now turns to the 1 January 2018 renewal, there are more questions than answers. How will Harvey, Irma and Maria impact capital levels in the sector? How are alternative markets responding? Will increased risk awareness encourage cedents to buy more protection? Is propertycatastrophe pricing likely to rise in loss-affected and unaffected regions? What about other lines of business: a broad market turn is unlikely but can any knock-on effect be expected in non-property classes and what will likely drive the market in the longer term? Or, in other words, where does the market go from here? All will be explored in the following pages. Irma seen from the space. Elements of this image are furnished by NASA

10 10 SECTION 2: CLEARING THE HAZE CAPITAL MATTERS The marked increase in the supply of dedicated reinsurance capital has been the predominant market driver for nearly a decade (see Figure 6). The entry of tens of billions of dollars of alternative capital into the sector, through various vehicles including catastrophe bonds and collateralised reinsurance, has created an unparalleled supply glut, with total reinsurance capital increasing by USD 137 billion (or 72%) between 2008 and Q Premium growth, in contrast, grew by a mere USD 30 billion (or 14%) as subdued GDP growth held back demand for reinsurance and several insurers retained more risk. Sector capital was at record levels heading into the 2017 hurricane season, at close to USD 330 billion. According to JLT Re estimates, this translated into an excess capital position of approximately USD 60 billion, with more than an additional USD 20 billion coming from catastrophe premiums. Reinsurers therefore face the elevated losses of 2017 from a position of capital strength and there is no question over the sector s ability to meet the costs of claims. Figure 6: Dedicated Reinsurance Sector Capital and Gross Written Premiums 1998 to Q USD billion Q2 2017E Traditional Alternative Catastrophe bonds Collateralised / sidecars Industry loss warranties Gross premiums (Source: JLT Re)

11 11 Figure 7 shows the strong historical correlation between the sector s excess capital ratio and global propertycatastrophe pricing. After eight consecutive years of strong capital growth and lacklustre premiums, the reinsurance sector has more capital relative to risk than at any time in recent memory. Circumstances today are therefore considerably different to previous large loss years. It must be remembered that in 2001 and 2005, for example, the sector was respectively entering and exiting the liability crisis which, all told, cost carriers hundreds of billions of dollars worldwide. This meant that the sector s capital position was both lower and more uncertain during these years, resulting in significant capital raising and the birth of several new reinsurance companies in the weeks and months following the 9/11 attacks and Katrina (otherwise known as the Class of 2001 and the Class of 2005). As things stand, there is unlikely to be a Class of JLT Re believes the sector s existing capital base is sufficient to service the bulk of losses sustained so far this year. Whilst the combined insured costs to the private market from Harvey, Irma and Maria could approach USD 90 billion to USD 100 billion 3, with approximately Figure 7: Excess Capital Ratio and Global Property-Catastrophe ROL Index Change 1999 to % 30% 20% 10% 0% -10% -20% -30% -40% Excess capital ratio at previous year end Global property-catastrophe ROL change at 1.1 half expected to be reinsured, these catastrophes should mainly affect earnings. Even accounting for other large losses that have occurred this year, including Tropical Cyclone Debbie, severe convective storms in the US, two powerful earthquakes in Mexico and Nate, 2017 s total claims are unlikely to impair significantly the sector s excess capital position. The impact on reinsurers 2017 earnings could nevertheless be sizeable, and a portion of the sector s capital buffer is likely to be absorbed. Losses will fall unevenly, meaning the (Source: JLT Re) aggregation of losses could erode excess capital for certain reinsurers. Those that have increased retentions or dropped layers are more likely to suffer outsized losses. But whilst the need to raise capital may materialise where necessary, the scale is not likely to compare to 2001 and Carriers may additionally partner with non-traditional sources such as pension funds and hedge funds before raising equity through more traditional channels. Structures such as collateralised reinsurance funds, special purpose vehicles and sidecars may, in fact, be the vehicles of choice given 3 Excluding NFIP claims.

12 12 they can be set up (and closed down) quickly and alternative capital providers are now familiar with such investments. Figure 8: Catastrophe Bond Issuance by Quarter 2006 to Q ,000 35,000 Any net reduction to sector capital is therefore expected to be manageable due to continued capital generation by major traditional players and, perhaps more importantly, sustained capital inflows from alternative sources. This is, of course, qualified by the fact that there is still over a month to run in this year s hurricane season and another two months for catastrophes to strike around the world. Any additional large losses before the end of 2017 will put additional strain on reinsurers capital. ALTERNATIVE FUTURE USD million 10,000 8,000 6,000 4,000 2, Q Q1 Q2 Q3 Q4 Capital outstanding (RHS) 30,000 25,000 20,000 15,000 10,000 5,000 0 (Source: JLT Re) USD million The continued involvement of alternative capital providers in the reinsurance market is likely to have an important bearing on pricing. Much of the sector s capital growth since 2012 has come from alternative sources. At mid-year 2017, alternative capacity had grown to account for about 21% of property-catastrophe limit. Prior to Harvey, Irma and Maria hitting the US and the Caribbean, investor appetite for reinsurance assets continued unabated, with catastrophe bond issuance reaching a record full-year high by the end of Q2 (see Figure 8). The collateralised reinsurance market has also seen similar, or even higher, rates of expansion in recent years. Some of this growth has been generated by moving into new markets. Motivations for ILS deals in new geographies such as Asia come in large part out of a desire to diversify portfolios away from US wind exposures. As ever, this involves a delicate balancing act between risk and reward as investors will be all too aware that the majority of losses at the beginning of this decade emanated from non-us territories, including Australia, New Zealand and Japan, as well as Latin America and Southeast Asia where risks are not always as well understood due to the lack of sophisticated catastrophe modelling tools. How the ILS market would respond to major losses has been a constant source of speculation for several years will provide definitive answers as investor resolve looks set to be tested like never before by the succession of costly events. In fact, this year will unquestionably be the most expensive for alternative capital providers. Irma in particular is likely to trigger significant ILS market losses due to its concentration in Florida and dominant retrocession position. Collateralised reinsurance and industry loss warranties (ILWs) are likely to be most heavily impacted, whilst some 144A catastrophe bonds are also thought to be at risk of triggering could therefore prove to be a landmark year for the future of the ILS market. Despite concerns expressed by some over investors long-term commitments to reinsurance, there are currently no signs of a mass exodus following these losses. But with Irma in particular likely to have a substantial impact on the ILS market, investors responses in the coming weeks and months will be important to securing sponsors long-term confidence. Cedents will be comparing collateralised vehicles willingness to pay, along with the speed of settlement, to traditional reinsurance.

13 13 Figure 9: Projections of Alternative Capacity as a Percentage of Total Property-Catastrophe Limit 70% Percentage of property-catastrophe limit 60% Other market estimates: ca. 40% by 2020* 50% 40% 30% 20% JLT Re s-curve estimate: 25% - 30% in the 2020s 10% % *Some market participants have estimated that third-party capital could make up approximately 40% of global property-catastrophe limit by The potential for trapped collateral in particular will be closely watched. Concerns around the availability of third-party capital linger as most collateralised deals are structured to set aside full limits once a certain percentage of deductibles has been reached. This means some third-party capital could be tied up until incurred losses are quantified. Much will depend on claims development between now and the end of the year. Historically, most hurricane losses have tended to incur within 120 days, meaning clarity may emerge before the 1 January renewal. Additionally, existing ILS players may choose to deploy capital opportunistically in order to replenish some trapped collateral, if profitable. Meeting cedents expectations in settling claims and offering capacity this year will go a long way to allaying concerns and strengthening existing relationships. Whilst capital may be unable to roll over in certain instances and a few providers will exit the market in the coming weeks and months, JLT Re continues to forecast strong alternative capacity growth over the next several years (see Figure 9). The growth trajectory is still expected to resemble an s-curve, as shown by the blue line in Figure 9, as opposed to some of the more ambitious predictions made by other market participants. But alternative capital clearly looks set to remain an important and permanent fixture in the reinsurance market. City of Miami Beach, Irma (Source: JLT Re) 0

14 14 Figure 10: Annual Change in Insured Catastrophe Losses and Global Property-Catastrophe ROL Index 1998 to Q USD billion Q3 2017E 0 Annual change in insured losses (LHS) Global property-cat ROL index (RHS)* * For the purposes of this chart, the ROL change applies on 31 December instead of 1 January so it aligns with insured catastrophe losses in each respective year. (Source: JLT Re, Swiss Re) Maria makes landfall in Puerto Rica in September Elements of this image furnished by NASA RISK AND REWARD Given that capital levels are likely to remain sufficient, and alternative participations are expected to continue to grow, what does this mean for reinsurance rates going into the 2018 renewal season? Whilst capitalisation will clearly influence pricing next year, the series of events during the 2017 hurricane season will be equally as important as carriers focus on the risk/ reward equation. Figure 10 shows that elevated insured catastrophe loss years have traditionally been accompanied by higher global property-catastrophe rates (and vice versa). Since the turn of the century, the largest one-year increase in average global property-catastrophe reinsurance rates followed the 9/11 terrorist attacks, when pricing increased by 30%. It was not only the quantum of loss that triggered this spike; the nature and consequences of a terror event which brought substantial property, life and liability claims were unforeseen. Post 9/11 risk reassessment was evident in changes to modelling assumptions, and in the formation of several public-private terrorism backstops and pools to ensure continued coverage availability. Challenged underwriting assumptions again played a crucial role in 2005, when the increased frequency and severity of hurricane losses following Katrina, Rita and Wilma led global property-catastrophe rates to record highs as insured catastrophe losses exceeded USD 100 billion for the first time ever. Tellingly, pricing did not move so dramatically in 2011, the only other year (before 2017) in which global insured losses exceeded USD 100 billion. A healthier and strengthening capital environment helped moderate rate increases in that year. Advances

15 15 made in catastrophe and capital modelling, enabling carriers to improve their understanding of risks, may have also played a role. PRICE TO PAY Reinsurance pricing next year will therefore reflect multiple, conflicting drivers. Whilst 2017 (re)insured catastrophe losses are likely to reach historical highs, there are a number of mitigating factors, including strong capitalisation, continued growth of third-party capital and loss experiences that, whilst large, fall within modelled expectations. But after five consecutive years of falling pricing, some upward pressure is likely. After all, the global, risk-adjusted average cost of property-catastrophe cover has fallen by a third since And reinsurers margins have been squeezed to such a degree that, on a forward basis, more than two-thirds of the top 22 reinsurers are expected to see a negative expected return on investment capital (ROIC)/weighted average cost of capital (WACC) spread in 2018 (see Figure 11). As things currently stand, any rate increase is more likely to resemble 2011/12 than 2005/06 or 2001/02. As a result, pricing increases should take place in loss-affected regions whilst loss-free property-catastrophe programmes in areas outside of hurricane-ravaged regions can expect to see more moderate price rises. The retrocession market is likely to be hit hard as elevated losses and increased demand for cover coalesce to drive rates up. This will impact alternative capital providers and collateralised vehicles especially, given their strong participations in the retrocession market. Varying impacts can be expected beyond North America. Reinsurers today have global footprints so the financial strains they suffer from hurricanes in the US and Caribbean will inevitably influence placements in other regions such as Asia and Europe, where they often dominate market share. The length of any market hardening could be mitigated by increased capital inflows into the sector. If capital entry persists, it could dampen and/ or shorten any period of higher pricing (as it did in 2011/12). Given the relative abundance of capacity in the market, JLT Re does not currently expect the losses of 2017 to have a significant impact beyond property-catastrophe lines, although rate decreases in other classes could now abate. Figure 11: Projected Economic Value Added for Top 22 Reinsurers in % 8% 6% 4% 2% 0% -2% -4% -6% -8% Whilst 2017 looks set to become the most expensive catastrophe loss year ever for the P&C sector, any rate increase for propertycatastrophe business is more likely to resemble 2011/12 than 2005/06. (Source: JLT Re, Bloomberg)

16 16 SECTION 3: THE LONG VIEW There will be winners and losers as the market adjusts to the post-2017 environment. In JLT Re s The Price is right Viewpoint report published last year, analysis showed that cedents with robust reinsurance programmes are best placed to navigate post-loss environments as they benefit from reduced earnings volatility and are able to deploy capital rapidly to support clients and take advantage of any new business opportunities. Likewise, cedents today with established and strategic reinsurer partnerships will now be best placed to react speedily to underwriting opportunities. BACK IN DEMAND Harvey 2017, flooding in Spring Texas, a couple miles north of Houston. Given P&C premiums ceded as a percentage of gross premiums written are coming off cyclical lows, demand for reinsurance is expected to increase in Supply/demand dynamics are constantly evolving: even prior to the substantial losses of 2017, there were clear signs of a shift on the demand side of the equation as strategic reinsurance purchasing by some buyers saw cession rates increase (see Figure 12). A continuation of this trend is now reasonable to expect. Figure 12: Simple Average Cession Rate of Top 20 Global P&C Carriers 2007 to 2017E 8.0% 7.5% 7.0% 6.5% 6.0% 5.5% 5.0% 4.5% 4.0% E (Source: JLT Re)

17 17 Figure 13: Calendar Year Reserve Development by Quarter for Top 30 Global P&C Carriers Versus Accident Year Reserve Experience 7% 6% 5% Strengthening phase 140% 130% 4% 3% 120% 2% 1% Overreaction phase 110% 0% 100% -1% -2% Danger phase -3% New danger phase? -4% Windfall phase! -5% % 80% 70% Average quarterly calendar year reserve movements as % of equity (LHS) Accident year loss experience, all lines (RHS) (Source: JLT Re) Even when accounting for any potential price increases next year, reinsurance remains competitive. This is likely to encourage cedents to reassess their purchasing approaches by strategically lowering retentions and optimising protection. Reinsurance has been a resilient and efficient source of contingent capital through several different market cycles and it continues to offer a strong value proposition today, especially as it is still often a more economical form of capital than debt or equity. This provides a positive backdrop for cedents as they will continue to have significant reinsurance support at historically low rates. ENOUGH IN RESERVE? Reserve adequacy will also be crucial in shaping the market s longer term future. Deficient reserves have, historically, been far more damaging to the sector s balance sheet than large catastrophes, as demonstrated by the liability crisis of Reserves have since been generally redundant, allowing carriers to support earnings and to compensate for historically low investment yields as well as reduced pricing. Reserve adequacy is notoriously difficult to predict but JLT Re last year conducted an exhaustive analysis of reserving trends which identified early evidence of isolated net calendar year reserve deficiencies. This research has been updated to show reported calendar year reserve movements by quarter for the top 30 global (re)insurance companies up to Q (see Figure 13). For comparison purposes, Figure 13 also includes accident year loss development for all lines of business (shown by the orange line). The analysis implies that the sector continues to be in a danger phase in which carriers are continuing to release large amounts of reserves even as accident year experience indicates

18 18 that redundancies are diminishing. But there are early signs this trend could be changing the fourth quarter of 2016 was the first time in almost nine years that P&C carriers experienced net reserve strengthening. This is a potentially critical milestone. Reserve deficiencies have historically sustained hardening markets. FUTURE VISION Events over the last couple of months are a stark reminder of how quickly things can change in the world of (re)insurance. Three successive major hurricane strikes in the space of 30 days, along with two devastating earthquakes in Mexico, have brought an abrupt end to a five-year period of below-average loss activity. Loss experience has ticked up, and whilst established market players are used to dealing with catastrophes of these magnitudes, some alternative capital providers and Florida carriers are facing their first genuine test. As a result, there is much speculation about reinsurance capitalisation and pricing heading into With high levels of uncertainty currently pervading the market, it is crucially important for reinsurance buyers to have detailed insights into key market drivers as the 1 January renewal approaches. JLT Re exists to provide market-leading analysis and bestin-class advice and risk transfer to support clients in managing market change. We look forward to doing just that in the weeks and months ahead.

19 19 Recent events are a stark reminder of how quickly things can change in the world of (re)insurance. With high levels of uncertainty currently pervading the market, it is crucially important for reinsurance buyers to have detailed insights into key market drivers.

20 20 CONTACTS David Flandro Global Head of Analytics London +44 (0) Keith Harrison Chief Executive Officer UK & Europe London +44 (0) Julian Alovisi Head of Research and Publications London +44 (0) Ed Hochberg Chief Executive Officer North America Philadelphia Helen Ferris Head of Communications and Marketing, London +44 (0) Stuart Beatty Chief Executive Officer Asia Pacific Singapore stuart.beatty@jltre.com UK & Europe North America Asia Pacific Middle East Africa This publication is for the benefit of clients and prospective clients of JLT Re. It is intended only to highlight general issues that may be of interest in relation to the subject matter and does not necessarily deal with every important topic nor cover every aspect of the topics with which it deals. The information and opinions contained in this publication may change without notice at any time. If you intend to take any action or make any decision on the basis of the content of this publication, you should first seek specific professional advice and verify its content. JLT Re specifically disclaims any express or implied warranty, including but not limited to implied warranties of satisfactory quality or fitness for a particular purpose, with regard to the content of this publication. JLT Re shall not be liable for any loss or damage (whether direct, indirect, special, incidental, consequential or otherwise) arising from or related to any use of the contents of this publication. JLT Re is a trading name and logo of various JLT reinsurance broking entities and divisions globally and any services provided to clients by JLT Re may be through one or more of JLT s regulated businesses _10.17