Catastrophe losses of $100bn a year are the 'new normal'

Natural catastrophe insured losses of $100bn a year are “the new normal” and reinsurers are now in a “multi-year” hard market, according to Christian Dunleavy, group chief underwriting officer at Aspen.

Speaking to Insurance Day, Dunleavy says the Bermudian insurer and reinsurer is adjusting its portfolio to that “reality”, which includes the added impact of climate change.

“Separating climate from weather is a big challenge and we feel you can’t be optimistic in this environment but have to be realistic and honest about the exposure out there,” Dunleavy says.

The recent floods in New Zealand are just the latest example of the “no shortage of events” that will continue, he adds.

On profitability, Dunleavy says the industry has not been servicing the cost of capital at a minimum in the past five years and certain years have been unprofitable “from a cat perspective”.

“Early post-Sandy to just before Hurricane Irma, so 2013 to 2016, were well-performing years but were very light cat years. The new normal is the past five years and we are presuming a market with $100bn in cat losses a year,” he says. “Fifteen years ago, it was probably $70bn a year, but there’s been a significant increase in the frequency of severe events, which requires a re-rating of the risk.”

The “wrinkle” in the reinsurance business is most policies are sold on an annual basis, so the market is not looking far enough ahead to consider longer-term trends.

Although there have been multi-year contracts for catastrophe for the past 20 years and it is “not uncommon” to write a portion of a book on a multi-year basis, they are more commonly sought when prices are low.

“The new normal is the past five years and we are presuming a market with $100bn in cat losses a year. Fifteen years ago, it was probably $70bn a year, but there’s been a significant increase in the frequency of severe events, which requires a re-rating of the risk”
_{Christian Dunleavy
Aspen Insurance Holdings}

“With so much of cat risk being written on to partner balance sheets, it is difficult to offer a lot of it on a multi-year basis because that capital generally renews on an annual basis as well,” Dunleavy says.

“My working assumption is we will trend more towards the annual so we can manage our exposures, manage our capital basis, because giving out too much multi-year capacity ties your hands when the view of risk changes or it becomes clear it isn’t being rated adequately. If before about one-third of catastrophe business was placed multi-year, then it is a lot lower than that now.”

In February, Aspen became a signatory to the UN-supported Principles for Responsible Investment, a global network of more than 5,000 organisations committed to integrating environmental, social and governance (ESG) considerations into their investment decision-making and ownership policies.

On work to improve its climate footprint and that of its clients, Aspen is “trying not to set hard-and-fast rules or timelines, because this is complex”, Dunleavy says.

“We don’t want to over-promise and under-deliver on something that is of value to the company and our staff, but we’ve done a lot of thinking on responsible underwriting as well as on how to support the renewable energy sector,” he says.

Aspen has partnered with California-based underwriter kWh Analytics to offer renewable energy property insurance. kWh has a proprietary database of more than 300,000 renewable energy assets – 30% of the US operating fleet.

The partnership, which also includes Swiss Re and Anthemis Group, “came in the front door as a submission from a broker”, Dunleavy says. “We were impressed with what kWh was doing and the huge amount of data it is able to put to work and, over time, it developed into this partnership.”

Less easy has been assessing risks from an ESG perspective, he says.

“With insurance, you know who you policyholders are, but you don’t have that level of visibility with your reinsurance portfolio. Right now, we’re focused on evaluating, testing and building the required tools and datasets, but the sheer number of ESG scoring tools that are available can lead to a dispersion of results.

“With financial ratings, you know most of them are the same, but the various ESG scores have much less overlap and there are too many to choose from.”

ESG criteria are becoming “politically sensitive” and attract “a heightened level of scrutiny”, so Aspen is taking the time to test scoring tools before committing to any single one. The company recently published its own ESG report, which reflects the “enthusiasm” for work on sustainability among its staff, Dunleavy says.

New appetite

Aspen’s insurance portfolio is longer -tail-oriented and it also includes a “fair amount” of transactional and management liability, Dunleavy says. In reinsurance, the restructuring of marine contracts “post-Ukraine” into separate placements is “tilting Aspen’s appetite” towards that line of business.

In property catastrophe, Aspen expects it will “grow margin but not exposure”, he says, while in most casualty classes rate is “still ahead of trend” and thus presents opportunity. Cyber insurance is performing well for Aspen, thanks to its “tightly defined” cyber strategy. Cyber reinsurance, however, is not a class the company is looking to grow materially in the near term.

As both an insurer and reinsurer, Aspen is acutely aware of the changes taking place to the “U-shaped” curve.

“Price improvements of the past few years have been driven on the insurance side, which is unusual because historically reinsurance cost drives the behaviour of insurance companies,” Dunleavy says.

Reinsurance had been “slightly out of favour” with investors but that is “swinging back now”, he adds.

“Reinsurance was at the bottom of the ‘U’ and insurance and retro were at the two top parts. Retro is still there, but reinsurance has now come up and the ‘U’ is changing into a different shape.”

Another change taking place is in the lower valuation of the “risk-bearing” companies in relation to brokers and managing general agents.

“As capital becomes tighter and more expensive, I think that dynamic will level out between distribution and risk-bearing, which is frankly more constructive for everybody,” Dunleavy says.

Aspen’s business is normally split 60:40 insurance to reinsurance, but that may adjust as reinsurance pricing rises in the hard market, he adds.

“I think we’re about 55:45 right now, but if reinsurance continues as it is then we could see the premium balance shift slightly further still.”

Aspen has a “third pillar” in its capital markets division, Dunleavy stresses, which underpins a lot of the capital the company offers in both insurance and reinsurance.

Natural catastrophe was historically a class that attracted third-party capital, but Aspen has such support for “a fair amount” of its casualty business and plans to expand that.

“Our thinking normally starts with how we share risk with the right kind of capital providers, including our own balance sheet,” Dunleavy says.

Challenging renewal

The January 1 reinsurance renewal was very challenging because everything – price, limit, terms, attachment point – was in the mix at once.

“It was the culmination of a pent-up period where prices had been declining for a long time. Like an elastic band, the harder you pull, the harder the snapback will be, and the snapback at 1/1 was severe,” he says.

The result is catastrophe pricing is starting to approach an “adequate rate”. The added dynamic of interest rate rises means if the “risk-free” rate is 5% to 6%, then the catastrophe risk ought to be 10 percentage points above that.

“Our main goal at 1/1 was to make sure our portfolio was constructed the right way so we were paid appropriately and attached at the right level.”

Pointing out brokers estimate an average rise of 20% in attachment points at January 1, Dunleavy stresses Aspen has “never been a first-level attaching kind of company”.

“It was good for clients to retain a little more risk and good for us as reinsurers to get back to the level where we’re covering what clients want. We’re not really there to provide earnings protection; it’s more about capital protection.

“Reinsurance attachment points had not changed in the past 10 to 15 years and so the increase was long overdue.”

Aspen “probably held out longer than others” on wordings because these were “too broad”. The market’s insistence on tighter definitions has meant many brokers witnessed “a degree of non-concurrency of coverage terms they had not seen before in their careers”.

The long-term soft market had meant clients got used to “pretty generous coverage that had scooped up a lot of the uncertainties”, Dunleavy says. “Now, it more about designing specific cover for their actual needs.”

Aspen’s external capital providers increasingly prefer, he says, “a much more tightly defined coverage stance”. A notable “clean-up” at January 1, he adds, was for strikes, riots and civil commotion being taken out of many contracts, while terror coverage was also improved.

Upcoming renewals

Dunleavy expects a continuation of the sentiment of January 1 in the upcoming renewals.

The Japanese market has already had rate increases since Typhoon Jebi, in 2018, but will have a further “material” rise in this year’s April 1 renewal, he says. Another dynamic, he adds, is the minimum rate for online coverage has gone up, reflecting “both the risk and the risk-free rate”, and is likely to rise further.

On the June 1 renewal, Dunleavy says Aspen is “somewhat underweight” in the Florida market and that is unlikely to change. Recent legislation in that state is “directionally better but there’s still more to be done there”.

“The companies we support in Florida are among the best operators with the best infrastructure,” he says. “There will be a bifurcation of companies that attract support and those that don’t.”

The companies that can count on Aspen’s support are “better capitalised, have real claims operations and are not virtual companies that outsource their functions”. They also have “more than one financial rating”, which reflects their higher capitalisations.

“Operating as a property insurer in Florida is a very specific skill set,” Dunleavy stresses. “A lot of people have tried it but not all of them have succeeded. We’ve been trading with the people we like for some time and we want to do more with them rather than take on a lot of new clients mid-year. Those new clients will need a proven track record of performing better than their peers.”

Aspen’s approach now is to “onboard more margin than exposure” because it believes this is a “multi-year” hard market.

“There’s going to be a lot of runway to leg into this,” Dunleavy says, “so we are going to stage our appetite to be consistent and incrementally step further into the market.”

In the near term, the company is not looking to add a lot of “attritional volatility” on to its balance sheet. “We are carefully managing our exposures and what we’re getting paid to take them on,” Dunleavy says.

Building analytics

Aspen is “comfortable” with the amount of catastrophe risk it has on its books and “just wants to get better paid for it and make sure there are no wildcards in there”, he adds.

“We think we are much better paid for property risk on the reinsurance side of the company now than we are on the insurance side, so we are emphasising reinsurance property over property insurance.

“We also have a fair amount of third-party capital that sits behind our cat book and we want to make sure we’re able to fully deploy that on behalf of those investors and get them the return they’re looking for.”

A hard market with, in addition, climate risk means data is more important than ever, Dunleavy stresses, and is why Aspen is investing in building its analytics capabilities.

“It’s a journey, not a destination, and there are elements of that which are not very glamorous,” he says.

“In an industry with a lot of legacy data, long policies, periods and liabilities, there’s a lot of wading through muck to get data standardised. The goal is to make the best risk decisions upfront and not having to figure out later what you wrote.”

The use of artificial intelligence and “triaging” data will enable the industry to “separate the signal from the noise and quickly”, he says.

“We want to be able to track the exposures and risks in our portfolio almost at the time of binding so we can have a high degree of comfort about managing volatility. It’s about bringing technology to the front line of our business to be ever faster and smarter with our decisions.”