Our recent Willis Insurance-Linked Securities (ILS) Update reported property catastrophe rate increases but hardly the return to a hard market that many have been predicting. Why is this so?
The modest increases seem surprising given the confluence of events. We have seen earthquakes in Chile, New Zealand, and Japan, floods in Australia and Thailand as well as tornadoes in Missouri, Alabama and elsewhere. (Re)insurer investment yields remain depressed. Finally, model changes have elevated the perceived U.S. hurricane and European windstorm risk substantially.
The Leading Explanations
Although some market segments have seen hardening pricing — retro rates on loss affected accounts have moved substantially — it is appropriate to ask why we seem to have avoided a broader hard market so far. One idea is that the loss activity was spread widely among market participants. Another possibility is that (re)insurers were very well capitalized coming in to 2010-2011 and remain so despite losses and reduced asset returns. Yet another is that unlike in 2006 rating agencies have taken a restrained approach rather than compounding the other factors.
The Capital Markets Alternative
Both of these and other explanations may be true; however, an intriguing possibility is that the capital markets have also helped delay the return of the hard market. One of the ideas behind the initial insurance securitizations in the mid-90s was to diversify beyond traditional capacity sources. At the same time, some hoped it would diminish the frequency and severity of the (re)insurance cycle itself. The idea was that the additional capacity would provide partial inoculation against hard markets.
Perhaps that is what we are seeing now. Capital has been available to support cat bonds, insurance derivatives, and collateralized reinsurance. Sure, prices have increased but still well within the range of a healthy market. New insurance-linked investment vehicles have started up and substantial sidecar money is potentially available if the cycle takes a more severe turn.
The maturing, deepening and diversifying of the capital markets property cat participation from 2005 to now may partially explain the delay in the return of a true hard market in 2011-2012 in contrast to the rapid emergence of a hard market after Hurricane Katrina. If so, this bodes well for policyholders as it may mean the market can now better absorb some substantial shocks to the system without the immediate severe dislocation we would have seen in the past. It also suggests that (re)insurers outside the property cat space should consider the potential impact of capital markets (re)insurance participation in changing the cycle dynamics for their sector. Developing capital markets capacity beyond nat cat and other segments where it presently exists could partially inoculate additional segments against hard markets too. Finally, it validates the work done early on to develop alternative sources of capacity from the capital markets and it reinforces their importance in achieving similar cycle dynamics in the future.
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