Calculated Risks

Reinsurance has always operated as the best hedging mechanism for an insurance portfolio, with reinsurers willing to accept a variety of well defined, well understood, and appropriately priced risks.

But when compared to events of the past decade, 2020 will go down as a year for the re/insurance history books.

By Jan. 1, 2020, the reinsurance market was already under pressure due to several factors from the last few years. Underlying issues, including more frequent and more expensive natural catastrophe losses and the changing nature and scarcity of retrocession protection utilized by reinsurers were already forcing reinsurers to recalibrate their pricing and capacity considerations for property lines of business. In addition, casualty lines such as commercial auto, D&O, EPL, healthcare, and monoline umbrella had produced an increased number of large losses. Overall, the frequency and severity in many lines of business had increased, and that impact was working its way through the reinsurance market.

And then the other shoe dropped: COVID-19 developed on a global scale. Eight months ago, the industry had no expectations that communicable disease would become a significant reinsurance issue. The challenge with COVID-19 is that it cannot be isolated by geography or product line nor accurately modeled or priced. Initial forecasts had predicted claims being made under property and event cancellation (as it relates to business income and a policy’s exposure to civil authority, government action) or, possibly, affirmative coverage for a pandemic or communicable disease that existed under a small subset of the industry’s policies. Although COVID-19 is not a covered property event under standard property coverages in the United States, the uncertainty of coverage litigation outcomes has led to a significant reaction in the reinsurance market.

Through the year’s second quarter, formal earnings announcements have reported $18.7 billion in charges for COVID-19 for the industry, according to Dowling. And that cost will only continue to rise, with varying estimates totaling as much as $80 billion. Across the industry, losses have affected all geographies and lines of business simultaneously. Moving beyond the more apparent property and event cancellation losses, workers compensation has emerged as a potentially significant exposure due to executive orders and legislative activity in certain states that have established various types of presumptions that employees contracting COVID-19 did so in the course and scope of employment. To summarize, COVID-19 presents a complicated re/insurance problem: it is producing actual losses that previously were discussed only theoretically as an emerging risk category—similar to a terrorism event prior to 9/11.

The 2020 pandemic exposures have been exacerbated by significant civil unrest losses, reviver statute molestation claims, the return of wildfires, an elevated season of named storms, and massive product liability settlements—all covered loss types, many of which will work their way into reinsurance programs. Reinsurance renewals were challenging beginning May 1, and this will likely continue into 2021, with reinsurers looking to improve the economics of treaty placements and being disciplined in how they allocate their capital.

Speaking specifically to the property reinsurance market, treaties are receiving exclusionary language related to pandemic losses. As a result, even in policies where communicable disease losses are not covered (due to existing policy conditions and exclusions, such as those relating to viruses, microbes, pollution and other contaminants), insurance carriers are closely reviewing their contracts and determining how to modify language to track with reinsurance exclusions. The addition of exclusionary language intended to harmonize insurance contract language with the reinsurance contracts will take some time to resolve. Until the industry is able to manage pandemic exposures through public/private partnerships, insurers will need to determine how each line of business addresses pandemic-related losses and to price appropriately for that risk.

Reinsurer positioning is evolving as the economic impact of COVID-19 continues to play out. Beyond property, leaders should anticipate downstream impacts across all industries and lines of business. Workers compensation, GL, D&O, EPL, E&O and surety are all lines of business that could be impacted directly or indirectly by COVID-19 losses. Reinsurers may need to downsize shares, reduce limits, reduce ceding commissions, and make other adjustments to their portfolio in order to improve their margins and strengthen their balance sheets. Achieving profitability in many reinsurance treaties and lines of business will be challenging for the remainder of 2020 and into next year.

However, there are some intentional measures we can take today to help lessen the financial impacts of a transitioning reinsurance market. First, pricing must rise to generate acceptable returns on deployed capital. A dollar of risk capital today demands a higher return than it did eight months ago due to new risks and lower future expected investment income, and the only way to overcome that hurdle is for pricing to rise on a macro basis, both for insurance and reinsurance risks. If we think of reinsurance pricing as an input to insurance pricing, then the cost of goods for insurance companies is now rising.

And insurance contract language will need to evolve to address changes in reinsurance contract wording.

Finally, insurers need to create a dialogue with their distribution partners to help them better understand the multiple changes occurring in their approach to underwriting and pricing. And the industry will need to communicate to their policyholders about what is and what is not covered and why pricing must rise to address increasingly uncertain financial results that have become more of the norm than the exception as 2020 so clearly demonstrates.

Mark James is chief risk and reinsurance officer at CNA.