How Reinsurers Can Win in the Game of Volatility

Executive summary: Reinsurance underwriting is all about finding equilibrium between reinsurers’ reason for being—reducing the volatility of cedents earnings—and producing stable profits in their own businesses. With new laws promising to change a Florida litigation environment that was out of control, reinsurers are selectively leaning in, even though catastrophe exposures, amplified by climate change, remain throughout the coastal state.

Successful reinsurance businesses strive for profit stability while promising to reduce the volatility that their cedents experience.

But now some reinsurers have been cutting their property-catastrophe exposures in high-risk regions. For them, the earnings volatility was just too high.

“Given the volatility of catastrophes, reinsurers are responding through rate increases, catastrophe modeling enhancements, greater stress testing and varying degrees of exposure reduction,” according to Moody’s in a January 2023 report.

“Nevertheless, the effects of climate change amplify earnings volatility risk for reinsurers. They will need to continue to manage their portfolios effectively, look for new opportunities and price risk appropriately in order to be able to continue to assume these increasing physical climate risks,” Moody’s said.

If reinsurers move away from volatility, they will start to make themselves redundant, an executive of a major broker told Carrier Management, in off the record comments, which have been echoed by other brokers.

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Natural catastrophes are here to stay, and, indeed, climate change is a growing factor in losses, but the broker suggested that this is where good underwriting and accurate disaster modeling come into play. (See related article: The Care and Feeding of Property-Catastrophe Models).

The reinsurance industry is in “the game of volatility. That’s what reinsurance is; that’s what reinsurance always has been,” he stressed. “We need to be able to price and underwrite better.”

But in certain markets, regulatory and legal environments have made it hard for normal laws of economics to work—making it difficult for insurers and reinsurers to operate profitably. One such market has been Florida, where high catastrophe losses since 2017 combined with inadequate prices and an out-of-control legal environment to make reinsurers reconsider their capacity deployment.

Out of necessity, the Florida legislature took action, enacting two laws last year—Senate Bill 2A and Senate Bill 2D, which (among other provisions) aim to resolve excessive litigation that had been raising the cost of homeowners insurance. SB 2A, enacted in December 2022, repealed two litigation drivers: one-way attorney fees and assignment-of-benefits (AOB) agreements in property claims. SB 2D, passed in May 2022, aims to reduce frivolous claims by limiting when attorneys can get fee multipliers in homeowners insurance cases and by barring attorney fees for those who are assigned benefits. (An AOB is an agreement that transfers the insurance claims benefits of a policy to a third party, which can inflate claims.)

“I don’t think people truly understand how much money has gone to the litigators and not to the policyholders,” which also has been driving up primary insurance rates for homeowners, according to Adam Schwebach, executive vice president and Tampa branch manager, Gallagher Re, in an interview with Carrier Management.

The numbers say it all. Florida is the site of 79% of all homeowners insurance lawsuits over claims filed nationwide while Florida’s insurers receive only 9% of all U.S. homeowners insurance claims, according to a 2022 Triple-I analysis of Florida Office of Insurance Regulation (OIR) and National Association of Insurance Commissioners data.

Net underwriting losses for Florida’s homeowners insurers have exceeded $1 billion in each of the last three years (2020, 2021 and 2022), according to OIR (Property Insurance Stability Report, July 2023).

Since the passage of the new laws, Schwebach said, there definitely has been renewed interest from reinsurers going into the midyear renewal period. After a tough Jan. 1 renewal period, reinsurers were able to achieve acceptable price levels that cover their cost of risk and consequently have begun to redeploy their capacity, he indicated.

While there are plenty of headlines about national carriers pulling out of the state, he noted that “Florida domestics,” or locally domiciled insurers, are staying put. “There hasn’t been a [local] company that’s voluntarily said, ‘This is not a geography where we can continue to make money and we’re going to exit it.'”

Pointing to another positive sign for the state, Schwebach said he is aware of at least 8-12 groups actively considering entering the Florida insurance market with new carrier startups.

“That would be fresh capital entering the state. They view it as an opportunity to come in without any of the legacy issues and in a new legislative environment that they view as extremely attractive.”

He said these startups tends to be a mix of stock companies and reciprocal insurers. (In the reciprocal setup, the carrier is owned by policyholders but managed by a separate entity called an “attorney-in-fact.”)

Positive Changes

Schwebach explained that the two pieces of legislation, which aim to curb excessive litigation, will take time to play out, but reinsurers are viewing the changes very positively. It was the legal landscape that “really caused reinsurers to step back and look at what assumptions they were making.”

While they understand cat risk, reinsurers determined that unless there was significant change in Florida, the social inflation risk, the political risk and the litigation risk that went along with operating in the state were “too hard and too burdensome for them to underwrite,” he emphasized.

“I give a lot of credit to the governor and the legislature in the state of Florida, because they have passed tort reform that should deal, over time, with a lot of these issues,” commented Juan C. Andrade, president and chief executive officer of Everest, the P/C insurance and reinsurance group. The legislative action taken is going “to help the environment in Florida for years to come because that’s a very good way to be able to tamp down on the fraud and abuse that has existed in the state.”

He emphasized that insurers and reinsurers have to make money, too. “And if you’re in an environment where there’s so much fraud, there’s so much abuse, and on top of that, you have climate-driven catastrophes, [reinsurers] can’t make the returns that they need to make for their shareholders.”

Reinsurers Remain Cautious

Participation in a market is not only about underwriting. It’s also about pricing, the regulatory regime and the tort system, Andrade said. “We have been consistent supporters of Florida for a long time, but we are cautious about who we do business with.” If some of the domestic companies in Florida are not as well capitalized as they should be, that’s a filter that also needs to be included in the underwriting, he said.

During Everest’s second-quarter earnings’ call, James Williamson, executive vice president, group chief operating officer and head of Reinsurance at Everest, noted that the company adjusted its portfolio in Florida during the quarter. “A number of the Demotech-rated Florida specialists, frankly, did not pass our financial underwriting standards, and we moved away from them and redeployed the capital elsewhere.”

Up until and including this year’s January renewals, the reinsurer SCOR significantly cut property-catastrophe capacity in regions exposed to climate change, according to Thierry Léger, the reinsurer’s Chief Executive Officer. “Usually, but not only, that’s what you find in lower layers, frequency layers in aggregate covers.”

However, during the April, June and July renewals, SCOR has been able to grow “at a low pace, together with the market,” he said, explaining that the more attractive areas grew more than others and that most of the growth came from higher premium rates. (He made his comments during a media briefing to discuss first-half results).

Swiss Re remains underweight in Florida, despite price increases after Hurricane Ian and the legislative changes, according to Swiss Re Group Chief Financial Officer John Dacey during a media briefing to discuss first-half results.

Although the legislative changes are “at least directionally correct,” it remains to be seen whether they will be effective in reducing some of the excessive loss costs that resulted from the AOB excesses in the legal industry, he indicated.

“Our overall view is this market still is not functioning as it probably should economically, and we need continued adjustments both in the structure of the market but also in the ultimate pricing for us to be more comfortable to have a market weight,” he said. He noted that Swiss Re is writing business for a number of clients in Florida, “but we remain cautious in the state.”

Dacey explained that one of the responsibilities of Swiss Re is to give clear indications in any jurisdiction of what prices are required to manage specific risks. “We’ve got…detailed models for what we expect losses to be and how expensive they will be. And as a result of that, we’ve charged our prices appropriately to recover the expected loss in any one year.”

However, what Swiss Re sees in some markets is either governmental authorities or regulators intervening in multiple ways—such as not allowing primary companies to charge adequate rates at the beginning of the value chain to cover expected losses, or encouraging non-economically based rates for reinsurance, or not requiring adequate levels of capitalization for insurers, he explained.

Improvements have been made in many jurisdictions, he said, but Swiss Re is not convinced they are functioning as well as states where there is less regulatory and governmental intervention.

Munich Re remains cautious about Florida market and continues to have a selective appetite, according to Christoph Jurecka, Munich Re’s chief financial officer. While there have been changes in legislation, it’s too early to see any benefits, he said, during a briefing to discuss first-half results. “There needs to be some stability in the market, and we also need to get some comfort again before we would be able to deploy more capital into Florida….”

Hannover Re has continued to provide Florida capacity mostly in the context of global or U.S. nationwide programs rather than on Florida-specific placements, said Executive Board Member Sven Althoff, in an emailed statement. “This is not necessarily a reflection on the pricing levels achievable in today’s market, but we prefer to write natural catastrophe-exposed business as part of a wider client relationship rather than looking at it as a standalone opportunity.”

Pricing Adequacy

Another roadblock for reinsurers in Florida was inadequate prices for the risks they were assuming. But that’s improving as well.

“Risk-adjusted rate increases for U.S. and Florida property-catastrophe covers [during the midyear renewals] averaged between 25 and 35%, although the level of increase is slowing,” according to an Aon report, titled “Reinsurance Market Dynamic–June and July 2023.”

“At these pricing levels, reinsurers were willing to support current terms in a meaningful way, and some have demonstrated appetite to grow and support increased demand for limit,” the report said.

Recent tort reform in Florida and early clarity around state reinsurance support in 2023 has brought a change in fortunes and encouraging signs of stability for that challenging market, said Aon.

Schwebach said the availability and cost of retrocessional coverage has played a role in reinsurers’ decisions to pull back their Florida capacity or redeploy their capacity.

When retro coverage is relatively cheap, reinsurers can make different underwriting decisions, he affirmed. On the other hand, there are certain reinsurers that are not nearly as dependent on retro coverage—often referred to as “gross-line underwriters.” They underwrite for their gross exposure, and there’s no retro to back them up, he explained. “They’ve been able to behave very differently over the past three to five years versus those that have been very retro dependent.”

These gross-line underwriters manage a portfolio against their capital, aiming to make a return regardless of what retro providers are charging for that risk, which tends to create more stability in underwriting and capacity decisions, he said.

Some retro renews at 1/1, and some renews at midyear, he said. “Depending on when those retro renewals come into play, reinsurers are often unable to make decisions until that happens,” which Schwebach explained can hold up capacity deployment.

Primary carriers really need consistency, he said. “For as long as I’ve been involved in reinsurance, it’s been viewed as a relationship business, and many of those relationships have held up over the past three to five years, during difficult renewal periods.”

However, Schwebach said, there are now a handful of primary carriers that are disappointed with the relationships they thought they had with reinsurers when they were simply let go without much explanation. “They were left to struggle and try to replace that relationship that they thought they had developed over a decade-plus.”

This article first was published in Insurance Journal’s sister publication, Carrier Management.