American International Group Inc. and other insurers avoided significant losses this year as a result of a spate of extreme weather, thanks in part to the reinsurance industry. However, increased reliance on these policies almost certainly means price increases are on the way.
“This year we’re seeing good demand and good price increases for reinsurance, and I think that just keeps happening,” Matthew Palazola, an analyst with Bloomberg Intelligence, said in an interview.
According to data from insurance brokerage Aon Plc, disaster costs are approaching $300 billion this year, with insurers expected to cover more than $100 billion of those losses.
This month, AIG CEO Peter Zaffino estimated global third-quarter catastrophe losses at $45 billion to $55 billion.
Paying those bills was made easier by reinsurers’ coverage — firms that backstop risks for insurance companies — which enabled AIG and its peers to survive the catastrophe-heavy third quarter and still report a profit. As extreme weather becomes more common, the industry’s reliance on reinsurance is likely to grow.
“If climate change has a truly material impact on the volatility of these events and the size of these events, then reinsurance becomes more and more important,” J. Paul Newsome, an analyst with Piper Sandler Cos., said in an interview.
Greater Severity
According to Aon, the insurance industry will exceed $100 billion in losses for the fourth time in five years in 2021, with rising global temperatures and the resulting extreme weather being key culprits.
“We’ve never seen consistent CAT losses at this level,” AIG’s Zaffino said on a conference call with analysts earlier this month, referring to catastrophe losses. The industry needs “to acknowledge that frequency and severity has changed dramatically as a result of climate change and other factors.”
According to Tom Johansmeyer, head of Verisk Analytics Inc.’s property-claim services division, it’s too early to say how much reinsurers will have to pay for Hurricane Ida and other third-quarter natural disasters. According to him, the process typically takes many months.
However, it is clear that those disasters wreaked havoc on reinsurers. Berkshire Hathaway Inc.’s property/casualty reinsurance business lost $247 million in the third quarter, compared to a profit of $99 million in the same period the previous year, according to Warren Buffett’s Berkshire Hathaway Inc. Some of the reversal was attributed to “significant catastrophe events,” such as Hurricane Ida, according to Berkshire.
Higher premiums can’t be far behind as reinsurers deal with more destructive natural disasters and inflation in the cost of construction materials.
Another option is to fine-tune the models they rely on to better understand their exposure.
“It all comes down to pricing the risks appropriately,” said Karen Clark, CEO and co-founder of risk modeler Karen Clark & Co. The firm estimated in a white paper this month that average annual hurricane wind losses could increase 10% to 19% by 2050 as climate change strengthens storms.
Capital from Outside Sources
While higher prices result from higher losses, there is one encouraging development for the reinsurance industry: financing has become easier to obtain.
“The path for capital to get to the reinsurance market has been well-paved,” Palazola at Bloomberg Intelligence said. “You can participate in this market a lot more ways.”
Rates in the sector are becoming particularly appealing to outside sources of capital, which could help to keep prices low, according to Palazola.
At the same time, higher reinsurance rates may be beneficial to hedge funds and pension funds that seek tangential investments such as catastrophe bonds. Because both markets rely on modeled natural-disaster losses, the pricing for these securities frequently resembles reinsurance rates.
And it’s been a brisk market, with $13 billion in bonds issued in the year to June 30, up $4 billion from the previous year, according to Aon data. Capital linked to insurance-linked securities increased to $97 billion, up from $91 billion.
Reinsurers, for their part, see an opportunity to address one of the most difficult issues confronting the global financial system and society as a whole.
“Due to our industry’s holistic view of the risk chain, we are uniquely positioned to understand the systemic risks of climate change, and deploy the capital needed to better protect people in the face of extreme events,” RenaissanceRe Holdings Ltd. Group Chief Risk Officer Ian Branagan said in a statement.