Following on from a recent post on windstorms in the US, I have taken several loss preliminary estimates recently published by firms (and these are very early estimates and therefore subject to change) and overlaid them against the South-East US probable maximum loss (PML) curves and Atlantic hurricane scenarios previously presented, as below. The range of insured losses for Harvey, Irma and Maria (now referred to as HIM) are from $70 billion to $115 billion, averaging around $90 billion.
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The loss estimates by firm depend heavily upon the risk profile of each. As a generalisation, it could be said that the aggregate US wind losses are averaging around the 1 in 100 loss level.
Given there was over $20 billion of insured losses from H1 and factoring in developing losses such as the Mexico earthquake, the California wildfires and the current windstorm Ophelia hitting Ireland, annual insured losses for 2017 could easily reach $120 billion. The graph below shows the 2016 estimates from Swiss Re and my $120 billion 2017 guesstimate (it goes without saying that much could still happen for the remainder of the year).
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At a $120 billion level of insured loss for 2017, the 10 year average increase from around $55 billion to $65 billion. In a post in early 2016, I estimated that catastrophe pricing was about 25% too low based upon annual average losses of $40 billion per year. We will see whether the 2017 losses are enough to deplete the overcapitalisation in the market and return pricing towards their technical rate. I wouldn’t hold my breath on that as although there may be material aggregate losses in the private collateralised market and other pockets of the retrocession market, the appetite of yield seeking investors will likely remain unabated in the current interest rate environment.
Although the comparison between calendar year ratios and credit defaults is fraught with credibility issues (developed accident year ratios to developed default rates are arguably more comparable), I updated my previous underwriting cycle analysis (here in 2014 and here in 2013). Taking the calendar year net loss ratios of Munich Re and Lloyds of London excluding catastrophe and large losses (H1 results for 2017), I then applied a crude discount measure using historical risk-free rates plus 100 basis points to reflect the time value of money, and called the resulting metric the adjusted loss ratio (adjusted LR). I compared these adjusted LRs for Munich and Lloyds to S&P global bond credit default rates (by year of origin), as per the graph below.
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This shows that the years of relatively benign attritional claims together with the compounding impact of soft pricing over the past years may finally be coming to an end. Time will tell. All in all, it makes for a very interesting period for the market over the next 6 to 12 months.
In the interim, let’s hope for minimal human damage from the current California wildfires and windstorm Ophelia.
Posted in General
Tagged 1 in 100 event, 1 in 200 capital, 1 in 250 event, 99.5% VaR, adjusted premium, AIR, Atlantic hurricane, California wildfires, catastrophe insurance sector, catastrophe risks, collateralised reinsurance, cost of capital, credit cycles, Eqecat, exceedance curves, fat tail, Florida windstorm, Hurricane Harvey, Hurricane Irma, Hurricane Jose, hybrid capital, ILS, ILS fund, ILS funds, ILS investor, ILS market, ILS multiples, ILS pricing, insurance linked securities, insurance sector, LMX spiral, London market insurers, loss exceedance estimates, Mexico earthquake, model uncertainty, natural catastrophes, nature unpredictability, net tangible assets, PML, probable maximum losses, property catastrophe pricing, rate on line, reinsurance pricing, reinsurance rates, reserve releases, return periods, RMS, ROE normalised, ROL, sources of uncertainty, South-East US catastrophe exposure, specialty insurance, subordinate debt, tail risk, tail VaR, TVaR, underwriting cycles, US hurricanes, US wind perils, vendor models, west coast Florida, Willis Re, windstorm Ophelia, yield seeking investors
Now that the US hurricane season is over without any material events, I had a quick look over a few transcripts of conference calls in the specialty insurance and reinsurance sectors to see if there was any interesting comments on where the market is going.
Nearly everybody claims to be mitigating the challenging market conditions by ducking & diving between business classes whilst keeping their overall underwriting discipline. The softness in the reinsurance market has spread into the insurance market, albeit not to the same extent. The reality is that results continue to be flattered by reserve releases, low loss activity and improved loss trends. Market realities are slowly being reflected in ROEs which are coming down to the low double digits.
Nearly all of the reinsurers are claiming to be the winners in the structural changes in the “tiering” of the market whereby cedants are reducing their reinsurance spend and concentrating that spend amongst a select group of reinsurers. Everybody has special relationships and the gravity defying underwriters! That same old guff was the typical response in the late 1990s.
The only interesting comment that I could find was from the ever colourful Ed Noonan of Validus who, after claiming that not everybody is as disciplined as they claim (he was talking about the large generalist reinsurers), said the following:
“It’s unfortunate because the market has had such strong discipline for the last decade. There are no magical segments that are beautifully priced, and the idea that a well-diversified portfolio poorly priced risk makes sense is an economic capital model-based fantasy.”
The last sentence reminds me of one of my favourite quotes from Jim Leitner of Falcon Management that “there is no real diversification in owning a portfolio of overvalued assets“.
My view is that few economic capital models in the insurance market which are currently being used to allocate capital to business classes are taking such arguments seriously enough and most are likely over-estimating the benefit of diversification across soft or under-priced portfolios.
Posted in Insurance Market
Tagged economic capital model-based fantasy, Ed Noonan, Falcon Management, improved loss trends, insurance pricing, insurance rates, Jim Leitner, low loss activity, low ROEs, market conditions, overvalued assets, real diversification, reinsurance market, reinsurance pricing, reinsurance rates, reserve releases, specialty insurance, underwriting discipline, US hurricane season, well-diversified portfolio