The long view: Blame it on the rates not the cat claims
19 August 2016
Many reinsurers have been posting disappointing half yearly results, with some of the larger groups reporting combined ratios of around 100%. While the finger of blame has been pointed at a rise in catastrophe (cat) losses, could the real culprit be overly optimistic pricing?
At $30 billion, the H1 2016 insured cat losses were indeed much higher than the $19 billion in the equivalent period in 2015 . This includes the tragic earthquakes in Ecuador and Japan, wildfires in Canada and floods in Europe (we all remember the floods threatening Euro 2016!).
Yet the H1 cat losses are in line with the ten-year average ($31 billion). Even when you strip out the annus horribilis of 2011, the ten-year average is $24 billion. This suggests that the favourable claims environment of 2015 is the blip, rather than what we’ve experienced so far this year. Data from modelling agency AIR Worldwide gives us average annual losses for any first half of the year of around $26 billion. Summer tropical cyclones are removed to derive an H1 estimate. But as the model coverage is incomplete (French flood risk, for example), the real figure of $30 billion once again doesn’t look that unusual.
If we apply this longer term view to movements in rates and their impact on combined ratios, then the real source of the earnings vulnerability begins to emerge.
In H1 2014, insured cat losses were $29bn, much the same as 2016. Soft market conditions were continuing to worsen, and not all cat losses have the same impact on results. Nonetheless, our analysis of the 11 largest reinsurers shows that their average combined ratio increased from 87.1% in Q2 2014 to 94.5% in Q2 2016. This suggests that the downwards pressure on rates, already fuelled by record levels of capacity, has been further driven by the unusually benign loss year of 2015, rather than tempered by a consideration of historical trends or by taking sufficient account of the inherent volatility in cat losses.
And if anything, insured cat losses could be about to climb above the historical average if above average hurricane forecasts for 2016 are correct.
Realism and innovation hold key
What’s needed is therefore a return to a more realistic long-term view of cat pricing and performance. And to aid this, we’re seeing ground breaking innovations in loss projection and risk management techniques. Rather than leading to undercutting prices, these developments will be the key foundation for competitive differentiation and bolstering long-term returns. These developments are explored further in the blog by my colleague Paul Delbridge.