Property cat treaty crunch turbocharges fac market

The boom in the property facultative market that began as insurers de-risked by cutting limits and appetite is now accelerating amid the retrenchment of reinsurers from cat, which is driving cedants to fill gaps and offload exposure lower down in their net retentions.

The dynamic is pushing fac – at least for property – into true hard market territory, with some sources suggesting the supply-demand imbalance is such that current conditions are even harder than in the aftermath of 9/11.

And the growth in the market over the last few years means that overall premium volumes are now approaching their previous peak.

Estimates for the overall size of the facultative market are hard to pin down, given the inconsistent classification by different market participants and where the business sits in their operations.

But in the US it has been suggested that this year top line at fac reinsurers could hit $1.5bn in property and $1.5bn in casualty.

Property fac had already been in a state of resurgence for the last few years with a flood of submissions that really picked up in 2019 amid fast-hardening conditions in the commercial property market.

Large commercial property insurers such as AIG and FM Global – which had previously put down huge lines and offered 100 percent capacity on some accounts – were dramatically cutting back limits as they reined in their appetite.

That created two dynamics that drove demand for fac at a time when there was also tighter supply with the pullback of the direct and facultative market in London.

Retail and wholesale placements had to be filled by more markets and many of those carriers joining the placements required fac capacity to support the lines they were putting down.

Meanwhile those underwriters that had cut back were using fac as a tool to maintain relevance in the market and relationships with key clients – a trend that continues in the current trading environment.

As Swiss Re Americas head of P&C facultative Ute Michaelsen told this publication: “Many carriers, especially the larger names, don’t want to completely relinquish control over an account. So one way to do that and to stay in the driver’s seat regarding pricing and terms is to buy fac.

“You also have smaller participants now playing on these accounts, and they typically have smaller balance sheets, so they need fac,” she continued.

Aon president Eric Andersen made a similar point when he highlighted the strong contribution from fac placements to the broking giant’s Reinsurance Solutions organic revenue growth of 9 percent in the second quarter.

“Facultative has been a great business for us over many years. And if you put it in the context of the overall market, where many of the insurers continue to remediate their portfolios, they often do that through the use of facultative placements in order to maintain their direct client relationship,” he said.

For many of the historically large players in commercial property insurance, much of the remediation has been done.

But there is no sign of a return to large limits deployment and, if anything, carriers are more cautious than ever of heightened frequency and severity around cat losses from primary and secondary perils in the current environment.

Meanwhile, inflation is an increasingly hot topic for property insurers as they face rapidly rising total insured values (TIVs) and the need to close the insurance to value gaps that have opened up at a time when rising materials and labour costs are also driving claims costs higher post-event.

These factors are driving an across-the-board focus on managing down cat exposures and tight control of cat aggregates as carriers look to manage earnings volatility and protect balance sheets.

The downward shift

Cedants are now facing what some sources are describing as a perfect storm.

After a harder 1 January cat renewal in Europe than seen for several years, the mid-year US wind-focused renewal has been described as the toughest in memory in the Southeast, where in some cases excess-of-loss (XoL) reinsurance capacity couldn’t be secured at any price.

Observers currently expect the market for property XoL to continue hardening up to 1 January even in the absence of a major cat event. If the hurricane season proves to be active, or other significant losses hit the reinsurance market, it could enter true hard market territory.

Meanwhile, quota share capacity is also increasingly tough to come by.

So insurers looking to manage down volatility and exposures – without further retrenching from the property line – are left looking to other alternatives.

And the property fac market is in pole position.

Santi Hernandez, CEO at Arch Re Facultative, told this publication: “We’re the natural place where people go to solve their problems and it’s our job to prudently solve them.”

Howden RE chairman Elliot Richardson, who is still a prominent day-to-day practitioner in the space, added: “The fac market will be driven by what happens in the treaty renewals, so expect a lot more demand.”

For Hernandez, current demand-side dynamics in the property cat market represent a fundamental shift.

“If you went back 10 years the traditional fac placement was just high excess and it was capacity driven. Now clients buy much lower down in the program to protect their nets,” he observed.

Where a decade ago it was about a property fac reinsurer’s ability to trade with $100mn in limit high up, now clients are looking for $4mn xs $1mn or $5mn xs $5mn facultative covers.

That demand for low-down cover has been heightened by the trend for reinsurers to seek to move away from lower layers on XoL cat structures.

“As programs are getting pushed up that net is potentially increasing as there’s less appetite [from treaty reinsurers] to play lower down, so we’ll continue to see our participation within the first 10 percent of the TIV.

“That’s just the evolution of fac. We are always filling in for either a change in perception of risk or actual reactions to losses,” said the Arch Re Fac executive.

The demand for fac is not just to address growing net retentions in relation to XoL treaties.

Ascot Re US president Rory Cline – another veteran of the fac market – noted the trend for cedants to cut back cessions on quota shares.

“If you bought a 70 percent quota share, now maybe you’re buying 35 percent, and that’s now coming back into the fac market,” he observed.

“The use of facultative protection allows an insurer to be more strategic in its reinsurance purchasing to take out some of the volatility and severity of certain accounts. That’s what is starting to happen right now, especially in property,” Cline continued.

More generally he agreed that cedants are taking bigger retentions because they are struggling to afford the necessary increases they are seeing on their property treaties.

Supply shortage

But he cautioned: “Cat is hard to buy. People want more and more cat in the fac market, but the price needed for this capacity is up substantially.”

Hernandez also pointed to the limited appetite for cat among reinsurers, whether treaty or fac.

“It’s a challenge to manage it and make sure that you’re making the most of the opportunities while taking care of your aggregation and being mindful of the limits you put out,” he said.

Michaelsen agreed. “There is a finite amount of capacity and I think the overriding goal for all of us is to get adequate returns for our capital. If you are in a hard market you are really looking to optimise your portfolio and your risk selection to get the most return on your capital. In that sense, fac can be more selective than treaty,” she said.

Richardson highlighted the demand-supply equilibrium in the property fac market.

“If the treaty market continues to refuse to take the cat you’ve got to find a home for it. Right now, on large US property insurance accounts you could literally place 10 times the amount of fac you place and still not find a home for it all. There just is not enough capacity,” he said.

For Richardson current conditions are harder than after 9/11, when the fac segment was more at the fringes of the reinsurance world with relatively few buyers.

“Now you have most of the panel buying and even with large increases in deductibles and prices they still want to purchase fac because they don’t feel happy with their net and treaty lines,” he stated.

That sustained level of heightened demand coupled with finite supply suggests the fac boom has plenty of road to run.

The fac barrier

With current conditions in the property fac market arguably as attractive as they have been in at least two decades, it might have been expected that an influx of capital would enter to capitalise on the resurgent segment.

Although there has been some increased participation and new entrants, that influx has largely not materialised and demand continues to strongly outpace supply.

Sources have said that one factor explaining the imbalance is the greater barriers of entry to fac compared to treaty.

Recent start-ups – such as Vantage and Conduit Re – have looked to grow meaningfully in treaty from the outset in part because the business can operate on a relatively low headcount without heavy infrastructure.

Fac does require a major investment in people and infrastructure to be able to handle the high volume of submissions and level of individual risk and account underwriting necessary to successfully write the business.

And like almost every area of the commercial (re)insurance industry, the fac market is facing a talent shortage.

“We are a subset of that whole war for talent in the industry,” suggested Cline.

“But I still think fac is a great space, and it’s a hell of a learning experience. Fac is going back to being the eyes and ears of any global insurance company,” he said.