Rates for renewals of California wildfire exposed reinsurance programs or coverage could see increases of as high as 30% to 70%, as both traditional and alternative markets smart after two heavy loss years, according to S&P Global Ratings.
Insured losses across the 2017 and 2018 California wildfire seasons reached around $33 billion, the rating agency noted, but because of timing of renewals S&P does not feel that rates have moved sufficiently higher to compensate both traditional reinsurance and alternative capital markets for their loss experience.
The California wildfires surprised insurance and reinsurance firms, given they fell outside of their modelled understanding of the risk.
In addition, due to the complexity of wildfire coverage, losses fell to both the property and casualty buckets of re/insurers, which added to the surprise for some.
Wildfire had been considered a secondary peril, but the events of 2017 and 2018 highlighted that these perils can pose just as significant a threat and potential for industry losses and finally the industry has woken up to the potential for significant impacts from secondary peril loss events.
“The past two years have clearly highlighted that these secondary risks are not to be taken lightly,” explained S&P Global Ratings credit analyst Hardeep Manku.
Reinsurance firms and alternative capital players have reassessed their risk appetites in light of the wildfires of the last two years, resulting in a diminished appetite across the industry for this peril and a desire for higher compensation for those prepared to underwrite it.
“Considering the limitations of the wildfire catastrophe models, if re/insurers were to underestimate this risk, they may end up taking outsize exposures that could result in a capital event and ultimately hurt their credit worthiness,” S&P explained.
Of course, after the last two years reinsurers and alternative capital providers are not prepared to take this risk, leading to an expectation for significant upwards pressure at future renewals.
S&P explained what’s led to this market dynamic, “With back-to-back above-average catastrophe years, reinsurance and alternate capital are smarting from the losses–especially those from the California wildfires. Several re/insurers are not comfortable with their understanding of the risk, which has led to the sector taking a cautious approach, with many curtailing or stopping their underwriting. This has constrained the available capacity for this risk.”
In particular, the impacts to retrocessional reinsurance capacity have dented the market and affected future risk appetite as well.
In the past, retro provided a cheaper form of capital and allowed those underwriting California wildfire risks, either on the property or liability side, to pass on their catastrophe risk.
Hence, rero capacity is constrained and what is available is more expensive, raising the prospects of it being more costly to manage the cat risk exposure within certain wildfire programs and insurance portfolios.
As a result, S&P Global Ratings says it expects, “significant rate increases for wildfire reinsurance between now and next year’s renewal seasons.”
Explaining, “This may not be as apparent because this peril is usually combined with the other reinsurance coverage for primary perils; hence, the impact of pricing changes for wildfires gets somewhat lost in the aggregated pricing. We expect this dynamic to influence the primary pricing as well, though more so in commercial lines than in personal lines.”
The existing set of catastrophe risk models let down the insurance and reinsurance industry, in underestimating impacts from wildfire events, S&P notes.
However, updated models now result in higher expected losses, which will also factor into the wildfire reinsurance pricing dynamic.
Reinsurance pricing has already moved for wildfire risks at recent renewals, but S&P believes this has not moved sufficiently to account for the two years of major losses.
In addition, multi-year policies and programs have not renewed since the wildfires, which means pricing did not move as much as hoped for in January or at the mid-year renewals.
While the insurability of the risk of wildfires is now in question, in some quarters, there does remain plenty of available capacity to soak up the risk.
But it won’t do so at any price.
“In addition, the transfer of risk to reinsurers and capital markets (through insurance linked notes), which had helped in the past, won’t be cheap,” the rating agency explained, referring to the few wildfire catastrophe bonds that were issued in advance of recent seasons.
Commenting on the outlook for rates, S&P said, “With reinsurers in slight disarray and given their lack of comfort with the California wildfire risk, pricing will inevitably increase. Reinsurance pricing could rise 30%-70% between now and the January 2020 renewals in view of higher expected losses under the updated models.
“Given inherent difficulties with the modeling, we expect a healthy risk margin to be built into those rate increases, given the uncertainties involved. We also expect tightening terms and conditions, with reinsurers pushing to make the definitions for loss occurrence narrower; currently loss occurrence can have different insurer interpretations.”
Primary insurance rates are also expected to continue to rise for the wildfire peril in California.
But this situation, of depressed retrocession capacity and much higher rates, could push reinsurers to look to their third-party capital vehicles as sources of retro.
In some cases, these structures do not always provide the transparency on how the risk within them is changing, compared to independently managed ILS fund vehicles, hence investors may want to ask questions about how they are being compensated for secondary perils like wildfire risk, if indeed they are simply being used as source of retrocession.
Most reinsurers offer good alignment with their third-party investors. But wildfire risk is one area where questions are worth raising, to ensure that an investors capital is used for profitable underwriting opportunities, not just to enable a re/insurer to upsize their book of wildfire risks at higher rates while offloading the peak catastrophe exposure to them.
Original Article Posted at : https://www.artemis.bm/news/california-wildfire-reinsurance-may-rise-30-70-as-market-smarts-from-losses-sp/