Retro market continues to harden amid limited supply

The hard property retrocession sector, which had formed one prong of the so-called “U-shaped” market over the last few years, is showing no sign of any easing that would relieve pressure on the now fast-hardening property reinsurance market.

The “U-shaped market” was a term coined to describe the hardening in the underlying property cat insurance market and the property retro market as property reinsurance pricing lagged.

But the retrenchment now being seen in property reinsurance – which caused a capacity crunch at mid-year and is likely to make for a tough 1 January renewal – is unlikely to be reversed by the emergence of any renewed retro support.

In its latest report on the sector last week, Guy Carpenter observed that the hardening pressures in the property retro market seen at 1 January have been sustained through 2022, with capacity for aggregate and low-attaching occurrence layers remaining tight in contrast to less supply constraints for layers further up the tower.

Rival Aon added that the retro market “continued to retrench” in 2022, with increased pricing and higher retentions, leading reinsurers to turn to the ILS market as a source of alternative retro protection.

That was backed up by Moody’s reporting that reinsurers are increasingly dependent on cat bonds and sidecars for retro protection amid contracting collateralised aggregate capacity impacted by the pervasive issue of trapped capital.

According to the rating agency, reinsurers have sponsored 15 cat bonds since June 2021 to access retro capacity, providing $2.85bn of limit.

The firm also reported that going into the January 2022 renewals, an estimated $15bn to $20bn of alternative capital was trapped, much of which was devoted to aggregate retro coverage.

That meant that UNL aggregate retro capacity was estimated to be down as much as 75 percent “and has been very hard to place as investors showed little interest in reloading capital”.

Aon said that there has also been a significant increase in the trading of industry loss warranties (ILWs) this year as reinsurers look for alternatives (see below).

In its report, Guy Carpenter highlighted some of the dynamics driving the retrenchment from the traditional retro product, including the sustained period of cat losses since 2017, growing climate-related concerns, inflation and modelling challenges.

In a presentation as part of its pre-Monte Carlo Rendez-Vous briefing, the reinsurance broker described a progressive hardening that led to a retraction in mid-year buying appetite.

Purchasing of retro continued to shift away from aggregate as overall limit bought was down 4 percent year over year.

Occurrence purchasing increased by 13 percent, but aggregate purchasing was down 39 percent amid limited availability of the product.

Guy Carpenter reported that ILS capacity supporting retro was down 17 percent overall, with retractions differentiated by fund. At the same time, rated capacity actually increased overall by 5 percent.

The impact on pricing was an average increase of 13 percent for occurrence limit in 2022, and more than 20 percent for aggregate coverage where it was available and purchased.

Looking ahead to the 1 January renewals, Guy Carpenter’s CEO of global specialties James Boyce said: “Retro capacity will remain somewhat limited for aggregate and low-attaching per-occurrence layers, despite material de-risking in 2022.”

In contrast, the “generally positive performance” of mid- and upper-level retro occurrence layers will remain attractive to markets looking to deploy capacity, he predicted.

“Buyers will look for a balance between spend and retention levels, supported by the improvement in terms and conditions of the underlying business,” suggested Boyce.

ILW trading surges

In its latest report on navigating the reinsurance renewal, Aon said it had seen a “significant increase” in trading in the ILW market through the 2022 renewal cycle as clients looked to make the most of the availability of capacity.

Buyer motivation came from several factors, including increased retentions in the traditional UNL retro market, pricing considerations across the curve – especially on the tail – additional demand for capital-related limit, and hedging strategies by ILS funds and assumed reinsurance portfolio managers.

The firm noted that in the first quarter there was strong interest after the 1 January renewal, but the bid-ask spread remained too large for some new trades to get bound.

That spread narrowed in Q2 as the availability of alternative capacity from the ILW market combined with increased demand, with trading accelerating.

“PCS also released a Hurricane Ida estimate which was considered modest relative to industry expectations. This resulted in the release of previously ‘trapped’ capacity becoming available for reinsurers to redeploy on other ILW trades,” said Aon.

Increased trading continued into Q3, with early execution of deals leading to reduced year-on-year pricing increases of 30-40 percent for some.

Aon reported that ILW pricing widened across the curve approaching the 1 July renewal as capacity became more limited.

At the same time, increasing cat bond pricing spreads led investors to show a preference for those issuances rather than ILWs, leading to reduced supply in the tail end of the curve for wind and quake perils. Aggregate capacity also remained limited.

In the report, the reinsurance broker said there has been renewed interest in the supply and demand for county-weighted ILWs to supplement traditional reinsurance programs that saw increased retentions or significant price increases with capacity challenges.

This was seen in Florida, where there was trading activity for low-attaching state-specific ILWs.

“We expect continued momentum in the market throughout the wind season and in preparation for the upcoming January 1 renewal season,” the firm predicted.