The gentle, downward drift that has occurred in global terrorism-specific reinsurance pricing since the market peak in 2002-2004 has recently given way to a flatter pricing environment as reinsurers evaluate their overall capital position and await the outcome of the ongoing Atlantic hurricane season.
Despite the sustained threat from global terrorism and modest losses from civil unrest and/or riot coverages in some international terrorism programs, the stabilization of terrorism pricing is not driven exclusively by these factors. Terrorism’s indirect linkage to the property catastrophe market is also important in that they are both low-frequency, high-severity exposures that require reinsurers, in some instances, to put out very large limits, often at a low rate on line (ROL). The combination of significant natural catastrophic loss activity over the last 18 months, along with major catastrophe model changes for US hurricane exposures, has broadly impacted the reinsurance industry’s capital position. While there is no direct link between terrorism underwriting and natural peril catastrophe losses or model changes, the reverberating impact of these factors on the market has necessitated an evaluation of all catastrophic exposure allocations and strategies, including for the peril of terrorism. Yet, assuming there is no major terrorism loss or other market-changing events, we do not expect reinsurers to significantly change their terror underwriting appetite in the near term.
The largest global terrorism reinsurance placements, and some of the largest reinsurance placements covering any peril, continue to be in support of the myriad non-US governmental/quasi-governmental, country-specific terrorism pools operating today. Similar in concept, but differing in operational structure, these entities continue to be the most efficient way to manage and cede terror risk. Accordingly, they are the preferred vehicle through which reinsurers deploy significant capital in support of terrorism-specific risk. Guy Carpenter representatives have recently visited the reinsurance market to begin preliminary discussions on various upcoming global pool renewals, and in this flattening pricing environment, there appears to be the same (but not greater) appetite for terror pool business as has prevailed for many years.
Be it natural perils or terrorism exposure, reinsurers prefer to deploy catastrophe risk capital to defined and specific geographies as a means to fully, yet prudently, leverage that capital. Therefore, reinsurers continue to be drawn to the defined and specific geographic nature of these pools. Also, the pools offer reinsurers the ability to allocate significant lines to one large program, further enhancing their efficiency. However, the attractive underwriting features of these pools have resulted in a competitive pricing environment. This environment has driven the downward pricing trend in terror reinsurance since the market’s peak, but is seen as moving toward more flat pricing today.
The cost of terror-specific reinsurance continues to be predominantly driven by the supply/demand equation rather than the sophisticated, technical pricing methodologies that reinsurers deploy to natural-peril catastrophe reinsurance pricing. Judged in that context, the assumption would be for terrorism-specific pricing to continue to decline. However, since reinsurer capital available to pay all types of low-frequency, high-severity catastrophic claims emanates from the same pool, the fact that loss events during 2010/2011 have depleted reinsurer capital does have an unavoidable knock-on effect to terrorism pricing. Hence, the general expectation is for pricing to level off going forward. While year over year risk-adjusted price declines are still possible and variances will be experienced by individual programs, the rate of year over year decline is expected to decrease.
Reinsurers hoping to gain an edge in terrorism underwriting have gone to great lengths to gain knowledge. They have made significant investments in various forms of research and development (R&D) around terrorism studies, reports and models. Ultimately, however, because terrorism is human-driven, purposeful and unpredictable, it is unlikely to be a peril to which reinsurers leverage their risk capital to any degree approaching that of natural peril-derived risk. With that in mind, we continue to see terrorism reinsurance pricing driven by factors that we have outlined in previous reports:
- Relativities to other terror programs
- Perceived prevailing terror risk levels
- The types of coverage afforded under the program and contractual definitions
- What the market will bear
Interestingly, in this flattening pricing environment, we see an increased willingness on the part of global terror reinsurers to consider providing coverage for terrorism programs (terror pools specifically) on a multi-year basis, with appropriate contractual pricing review clauses in the event of a loss. Some pools already purchase an element of multi-year coverage, and they are looking to expand on this in 2012, but only at no, or very small, premium over traditional annual coverage. Perhaps reinsurers’ willingness to lock in multi-year agreements on terror programs indicates that apart from program-specific loss activity, they do not expect circumstances to drive market pricing levels upward on a broad basis.
Guy Carpenter estimates that approximately USD6 billion to USD8 billion of terrorism capacity is available in the US market, with an unknown percentage of that currently in-force today through terrorism-specific treaties or as part of terrorism coverage afforded under other multi-peril treaties. The US Treasury’s TRIA program does not currently buy reinsurance. Because of this, the deployment of reinsurer capital to US terrorism exposures is done on a transaction by transaction basis for individual insurers.The insurers are managing their retention under TRIA or building individual risk capacity for terrorism.
Multiple factors dictate how much coverage is available for any single US program including geography, the type of insured and whether nuclear, biological, chemical and radiological coverage is sought. However, depending on those factors, the maximum per program limit is possibly in the range of USD500 million up to a theoretical USD1 billion plus.
On balance, some of the leading terror reinsurance underwriters in the world would ideally like to write more US terrorism business with a good spread of risk amongst geographic zones and hazard classes. However, activity for US standalone terrorism programs is restricted by competing risk management priorities and the presence of TRIA.
As mentioned earlier, the largest transactions in-force today for terrorism provide coverage to individual national pools such as the Australian Reinsurance Pool Corporation (ARPC), Gestion de l’Assurance et de la RÉassurance contre les Attentats (GAREAT ) in France, the Danish Pool and others. Today, approximately USD9 billion of terrorism reinsurance limit is in-force across major global terror pools.
Despite the tremendous scale of the limit purchased by these global terror pools, the market’s supply of potential capital to these pools continues to exceed the demand. As evidence, we note that in terms of reinsurance capacity offered to some of these pools through reinsurance brokers, we know of approximately USD1.4 billion in the aggregate of potential limit that was not taken up during 2011 placements. If a complete set of detailed data outlining authorizations and signings were available for all global pools, we would not be surprised to see the over-supply estimate pushing toward the USD2 billion mark.
This over-supply of terrorism reinsurance globally, combined with the fact that the US government-sponsored TRIA program does not purchase reinsurance, will serve to continue to stifle upward pressure on pricing, barring other, significant marketchanging events.
The global aggregate sum of reinsurer capital available to be allocated to terrorism has not changed appreciably over the past five years, and it is not expected to change in 2012, barring major events or very strong currency movements. In concept, we likely remain at or near the peak in available terror risk capital. Many believe that there are more possible factors that could theoretically make terrorism reinsurance capacity harder to come by than there are macro factors that will significantly increase supply from this point forward.
The most obvious factor that could decrease the supply of terrorism capacity in the near term is the potential for further knock-on effects from additional major global natural-peril catastrophe losses. These would include losses like those that have recently emanated from Chile, New Zealand and Japan in a mini-cluster and at a greater frequency than has typically been seen in the past or would be estimated by modeling. Reinsurers would explain that one of the reasons that they write in these zones is for the purpose of diversifying some risk capital away from other global “peak” concentrations of catastrophe risk. Often, these diversification plays are typically written at very competitive technical pricing levels. As this combination has performed relatively poorly for reinsurers recently, any ongoing, future exacerbated loss activity of this nature would understandably impact capital deployment to these types of strategies.
TRIA (TRIPRA) Update
President Barack Obama made pronouncements in May 2009 and again in February 2010 that the US administration was looking to cut certain elements of TRIA (TRIPRA) in upcoming budget proposals. Since then, the issue has gone largely silent in the face of other, more pressing financial matters. This does not mean the issue will not re-emerge. But for now, we believe that the administration and Congress may be content to allow TRIA to run its course, and they will not begin debate on the matter until a normal timeframe prior to TRIA’s scheduled expiration in 2014. However, an unexpected change of policy might put TRIA squarely back into the ongoing budgetary battles in the US Congress. This could certainly be the type of “shock” event that quickly changes the relatively quiet US terrorism reinsurance market, and correspondingly, impacts the global terrorism reinsurance market via a spike in overall demand.