Casualty QS heads to another inflection point as underlying momentum wanes

Reinsurers are again beginning to question the sustainability of casualty and professional liability quota share ceding commissions that are largely back in the 30 percent or more range amid the steady drip feed of data points indicating a deceleration of underlying rate increases.

This publication reported in June that some casualty reinsurance buyers have been looking to downsize quota shares to retain more net and benefit from the improved margins on the original business.

At the same time there have also been moves by insurers to push up cede commissions and shift towards adding excess of loss protections instead.

Reinsurers, for the most part, have acceded to the demands of buyers, as the surge in underlying prices has driven significantly higher premium volumes on business where the remedial work of insurers has dramatically shortened underlying limits.

That means that casualty reinsurers have on face of it been taking in more premium for less risk on quota shares.

Naturally that has led to a degree of acceptance when cedants have looked to improve terms on quota shares with a point or two of extra ceding commission, or have looked to cut back the percentage of their book they cede.

For the most part, there is confidence that rate increases continue to comfortably outstrip loss-cost trends, at least based on current assumptions.

As one reinsurance broking source put it: “The market has addressed social inflation with the massive reduction in limits and massive increases in premiums.”

Some reinsurance underwriting sources are confident that the steps taken by cedants have altered the dynamics of writing the business as a reinsurer, and reluctantly accept that some reinsurance buyers will look to retain more of the benefits of their actions.

“Clients are trying to take more net because this is as good as it’s ever going to get. They’re going through this year with rate on top of rate on top of rate, and the economic recovery means insureds can afford the rate increases for longer.

“The rate adequacy is there, the limit deployments have halved, terms and conditions are tighter and people are prepared to pay the cost of cover,” one senior reinsurance executive commented.

Rate deceleration

But while nobody expects to see a softening in the casualty or professional liability insurance market this year, the consistent theme of recent months has been a growing weight of evidence that momentum is slowing quarter by quarter.

That deceleration was arguably most noteworthy in data from Aon reported by this publication in late August.

The broking giant revealed that average rate increases for large, complex umbrella/excess casualty accounts in the US had fallen back by nearly two thirds from 44 percent to 15 percent in Q2 compared to the first quarter of the year.

The most challenging 20 percent of accounts the firm places slowed from rate increases of 103 percent in the first three months of the year to 51 percent in Q2.

Umbrella/excess on large, complex risks had been one of the toughest segments of the market to place, but now there is clear evidence of significant easing, while data from Aon also revealed moderation of rate increases in other areas of casualty.

As well as appetite from incumbent carriers, there is also evidence that start-up insurers and MGAs that have entered the casualty space in the last 12 months are beginning to have an impact.

The message has been consistent across a range of other data sources, including the Council of Insurance Agents & Brokers’ latest survey, which revealed deceleration across the board with the exception of cyber.

Unsustainable economics

The questions for reinsurers are how long before decelerating underlying rate increases turn into rate reductions, and how long before falling rates begin to converge with rising loss costs?

Speaking to this publication as part of our #ReinsuranceMonth programming, TransRe president and CEO Ken Brandt said that the quota share market can currently support the level of cede commissions paid to insurers.

“That’s economically feasible in this part of the market because of all the price increases. But it’s not very sustainable through the cycle,” he commented.

The executive said that hard market conditions in the US casualty market had not been driven by a lack of industry capital but by poor results, social inflation, loss emergence and anaemic investment yields.

“So there are reasons that it is better, and there’s likely more work to do,” he added.

And he warned that when the market turns, there will not be enough business with loss ratios in the 50s or 60s range needed to support cede commissions in the 30s to maintain profitability for reinsurers.

Other industry executives have questioned whether cede commissions are at a profitable level for reinsurers even at current underlying pricing on some deals.

“You’ve got to believe some very magical things about how those losses are going to turn out to offer some of the ceding commissions we’ve seen and those are deals we are not doing,” said Everest Re’s head of reinsurance Jim Williamson speaking on a recent panel moderated by this publication.

Two-speed market

Brandt also described a market that is breaking down into two major camps of buyers.

The first is where insurers are confident in the book of business they are writing and want to take more net. The second is where cedants are continuing to reunderwrite their portfolios, are under new leadership or are a new company, or are not certain about their loss emergence.

As this publication has previously reported, there is also a school of thought that some insurers are looking to rapidly build a buffer from premiums that have doubled or more in some challenged areas of their portfolios against losses they expect will still emerge from the underwriting years at the end of the soft cycle, and the potential for an uptick in claims as the courts reopen post Covid-19.

If the latter turns out to be true, buyers may find themselves in greater need of quota share reinsurance in the coming years as their earnings and balance sheets come under strain from prior-year development.

Senior broker sources also observed that there is a different level of confidence among some carriers by line of business.

They noted that most of the upward movement in cedes has been in areas like financial lines, where there was significant underlying rate need and buyers wanted to take advantage of a greater portion of the increases that were achieved.

“Excess casualty and some other casualty lines are more complicated in terms of the limits, the latency and exposure.

“The tail is marginally longer and there’s more uncertainty so you see some of the behaviours you saw in somewhere like financial lines, but it’s not as magnified and I don’t think people are as willing to keep as much net,” they commented.

For now at least reinsurer sources appear confident that underwriting on the underlying business will not regress to soft market behaviour, despite signs of waning momentum on pricing.

“Those days are not coming back anytime soon. Even if rates go down you won’t see things get that dramatic,” said one senior casualty treaty executive.

But he added that it was also critical that reinsurers hold the line too.

“In general we need to budget for more margin to cover the unknown because the severity issue has not been addressed,” said the underwriting executive.