In its latest analysis, Moody’s revealed that its outlook for the global reinsurance sector has shifted to positive. In a media briefing to discuss the analysis, Brandan Holmes (pictured left), senior vice president of credit at Moody’s, attributed this to a variety of factors including rising premiums, tighter policy conditions, good risk-return dynamics, and strong investment returns.

“Overall, what is helping to support tighter underwriting terms and stronger pricing?” Holmes asked. “We think it’s a reassessment of risk and a greater focus on good risk-return dynamics for reinsurers. Supply and demand for reinsurance capacity has also remained more balanced than at the peak of previous challenging market cycles, which is helping reinsurers stay disciplined.”

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He noted that the period also saw a good performance by reinsurers compared to primary reinsurers, largely due to a shift in exposure to small and medium-sized events, or secondary risks, from reinsurers to primary insurers. Added to this is the fact that these secondary risks have been a very large contributor to total losses in the past few years.

What are the reasons for Moody’s positive ratings for the sector?

Three key factors underpin Moody’s positive outlook for the sector and its belief that favourable conditions will persist at least into next year – despite the fact that price increases appear to be slowing and the agency expects interest rates to start moving downwards. “The first factor is the upward reassessment of risks, particularly in response to the frequency and severity of so-called secondary risks, which the industry has found difficult to model and manage. This supports continued strength in pricing and terms and conditions.

“Secondly, there has been a structural shift in exposure to these small and medium-sized events, from reinsurers to primary companies, and that has really mitigated a lot of the earnings struggle that reinsurers have faced in previous years. And thirdly, in contrast to previous tough market cycles, there has been only limited inflows of new capital into the sector. So we think those three things will support underwriting earnings or at least risk-adjusted underwriting earnings, even if rates come down a bit.”

Given how secondary risks – as a proportion of the total loss mix – have steadily risen over the past few years, Holmes highlighted how the challenges around managing these risks have led to a higher visibility of risk. Adding further insight into what is driving the increased insured losses from these events, Joss Matthewman (pictured right), senior director of climate change product management and strategy, emphasised that rather than calling them ‘secondary risks’, it would be more accurate to refer to them as ‘reward risks’. While these risks can still generate significant losses, they typically impact insurers’ and reinsurers’ profits, not capital or solvency.

The Five Factors Behind the Rise of “Profit Risk”

“There are five factors that are really driving the increase in claims (that we’ve seen) over the last few years because of these earnings risks, and that includes population migration and urbanization,” Matthew said. “In terms of migration, we have people moving from low-risk areas to high-risk areas, so we have more people at risk.

“But we also have urbanization. We see migration in the form of people moving to urban centers, and that’s a problem because the impacts of events like hail or tornadoes are usually quite compact. So if we concentrate exposure in one area like an urban center, we get an all-or-nothing impact, compared to a population that is more dispersed across a less urbanized area. The other problem with urban exposures is that the built environment is problematic in terms of rainfall, runoff and drainage, which exacerbates flood losses in those areas.”

The second challenge is economic inflation. Reconstruction and construction costs are rising globally, which will impact reconstruction costs as a result of these events. “But we also have social inflation, which is changes in claims behavior that are due to a variety of social factors,” says Matthew.

The challenge here is that some of these trends may be emerging while others may be recurring or one-off phenomena, and we may or may not see them again depending on legislative changes that prevent their recurrence. However, he noted that the effectiveness of legislation may vary and must be tested, usually by the next market event.

The third factor driving earnings risk is building vulnerability, which he highlighted as a challenging factor because as buildings age, they become more vulnerable. “So we would expect to see losses increase over time as a result of that,” he said. “But as newer buildings are built, or buildings that have been rehabilitated, perhaps after a recent event, those buildings tend to be less vulnerable. So there are some competing influences here and it’s not immediately clear which one will win out.”

Changes in building practices may also be responsible for some of the increase, he said. For example, 30 years ago, many roofs didn’t have solar panels, but that’s an increasingly common building practice today, exacerbating damage from wind and hail events.

The fourth factor is about insurance uptake. Increased uptake is a positive thing, but it naturally leads to an increase in the overall losses incurred by the industry. This will be particularly exacerbated if the increase in uptake occurs in areas with greater population migration and urbanization.

Understanding the role of climate change

“The fifth is climate change,” Matthew said. “The question is, to what extent, after all of the above, is climate change driving the signal that we see? It’s not really as fundamental a driver as the facts (mentioned above). Overall, the impact of climate change on disaster risk is complex and highly uncertain, due to the relative rarity of these events. Across a geographic area or hazard, we may only have a handful of these earnings risk events over several years.

“So it’s really hard to separate climate change trends from natural year-to-year climate variability. We have more confidence in some risks than others, even within individual risks. For example, for convective storms in Europe, we can have more confidence in the impact of climate change in some areas within that region than in others. However, overall, we expect climate change to be a much smaller contributor to those increases in losses, which we see in those profitable risks compared to the previous four factors.”

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