London Market (LM) insurance firms have been anticipating an increase in premium rates following the losses from the 2017 catastrophes, including Hurricanes Harvey, Irma and Maria (HIM). Drawing on our 2018 renewal pricing analysis, we look at whether the anticipated rises have materialised, whether the rebound is sustainable and how much impact it’s going to have on returns.
Lloyd’s market catastrophe claims costs jumped to £4.5 billion in 2017 (£3.6 billion from HIM), one of the biggest hits in the past 15 years (only 2005 and 2011 were higher when indexed). Largely as a result of the 2017 catastrophe losses, the Lloyd’s combined ratio (CR) jumped to 114% in 2017, up from just under 98% in 2016. Other important factors impacting on the CR included a lower level of reserve releases and increased attritional losses both of which are linked to the current soft cycle and will be impacted by the rate changes discussed below.
How has HIM affected pricing projections? According to PwC's market view, LM firms had been anticipating premium rate falls of between 1-2% prior to the 2017 hurricane season, with almost all business lines negative, continuing the prolonged soft market slide. Following HIM, projections turned to rises of around 3-4%. At the end of 2017, many firms were also expecting an increase in business volumes beyond rate rises alone.
Has this optimistic outlook been realised? Our view of first quarter renewals indicates that the 3-4% increases are coming through, with the uplift being even stronger in the most affected classes such as property reinsurance. However, apart from a few pockets, few firms have seen the additional rise in volumes.
The price increases are welcome news for firms that may have been wondering when and, even if, the downward slide might ever be reversed. Yet, the boost is only relative. Following a 4% drop in rates in 2016 and further 2-3% fall in 2017, we’re back where we were in 2016. And that followed 4% and 5% reductions in 2014 and 15!
2018 has seen some sporadic withdrawals from certain classes of business under pressure, but nothing like enough to make any real dent on the excess of capacity. Our analysis shows that around a fifth of plans still expect to make a loss (post the rate increases), better than the third we saw going in 2017, but still unsustainable, especially if we have a repeat of the severe claims costs of 2017.
So, what are the prospects ahead? The price rises seen in 2018 have been nothing like the increases that marked the turning of the cycle following the losses from Hurricanes Katrina, Rita and Wilma in 2005. Indeed, given continuing over-capacity, the rebound of 2018 could end up being no more than a ‘dead cat bounce’.
This is due to a market that has delivered a creditable 7.2% average return on capital over the past five years and 9.2% over the past ten, which is why it continues to attract so much new capital.
A more optimistic view would see a bottoming out of the cycle in 2017 and the beginnings of a continued upturn ahead. The rate of decline in premium prices had already been slowing prior to HIM and the hurricane losses have accelerated this positive trend.
However, even if rates are finally moving upward, the impact on returns is likely to be gradual within today’s longer and flatter underwriting cycle. It could be several years before rates climb back to more favourable levels. This highlights the vital importance of underwriting discipline, cost control, squeezing out claims leakage and sharpening capital management in sustaining long-term returns. The need to focus on the fundamentals rather than simply relying on a pricing upturn is further underlined by the fact that while Lloyd’s delivered a combined ratio of 114% in a trying 2017, many of its major US and Continental peers managed to better this and a number still came in under 100%.
So, yes, our analysis does suggest that there is light at the end of the tunnel, but it’s currently only a glimmer. And a surfeit of capital and capacity means that the tunnel is a long one. With a hardening of rates no longer enough to offset many years of soft prices, the LM firms that are set to deliver the most favourable returns aren’t simply waiting for the cycle to turn, they’re actively improving efficiency, testing reserve adequacy and adding discipline now.