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Property cat: Chicken today, feathers tomorrow

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Once upon a time, there existed property catastrophe predominant reinsurers. These reinsurers benefited from huge surges in rates following major losses and were able to report strong (if volatile) earnings. Cat losses were infrequent, and vendor models validated the capital deployment strategy.

This went on for some time, and investors, management teams, and counterparties were happy. So let the good times roll! Unfortunately, these results could not be kept secret, and outsiders got wind of them.

First, the new ILS capital attacking the opportunity was a trickle, and the industry expected these newcomers to go away. But low barriers to entry and returns that were uncorrelated to the broader capital markets soon drew in more and more new money. Oh, these pesky outsiders!

The trickle turned into a flood, and the low-hanging fruit was gone. Cat returns fell precipitously. However, all was not lost because the wind hadn't blown since the ILS tipping point in 2012/13. The period of benign losses ended in a vengeance with 2017 losses in excess of $100bn, and a string of subsequent bad years that has continued through 2021. Both ILS and traditional reinsurers have suffered through these events.

Investors looking to bet on cat had forgotten (or never learnt) what Bill Berkley says about reinsurance business on WR Berkley earnings conference calls. "It's chicken today and feathers tomorrow."

In recent months, the weak run of results in cat has started to be paired with pressure from other sources. Ratings agencies have started to discuss the impact of climate change and unmodeled losses, with S&P noting that reinsurers exposure to cat risk could be underestimated by 33%-50%. Modeling firms are also starting to rethink the level of normalized losses, as they play catch-up.

Modeling firm AIR released a climate report predicting more significant cat losses due to weather events caused by climate change affected global atmospheric conditions. AIR noted that while global average catastrophe losses over the past decade have been around $75bn, future modeled losses are expected to be much higher, with its modeled aggregate average annual loss rising to $106bn for 2021 following various updates.

This report comes against the backdrop of the COP26 Climate Summit in Glasgow this week and predictions of calamity from world leaders.

This discussion leads to a common theme emerging from this quarter's conference calls where a key theme was how catastrophe risk is being managed and underwritten.

Some of the Bermudians emphasized that they were pulling back from cat, or leaning into diversification through growth elsewhere. Although past results may suggest that this will just lead to chances to disappoint in more segments.

Others of the Bermudians chose to lean into their strengths.

Historically, the different approaches have translated into value creation for RenaissanceRe outpacing Everest Re and Axis over the last ten years.

Below, we investigate the different approaches reinsurers have alluded to this quarter and the long-term repercussions of those approaches in the future.

Axis Capital took the most obvious choice: if investors are catastrophe-shy, we’ll reduce catastrophe exposure.

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In the most apparent – if simplistic – strategy, Axis decided to give skittish investors what they wanted and reduced exposure to catastrophes (a strategy which it has been pursuing for two or three years now).

In the short term, at least, this appears to have assuaged nervous shareholders; Axis Capital’s stock has surged since the firm released its third-quarter earnings last Wednesday, up 4.1% from $51.62 to $53.74, while Everest Re and Renaissance Re are down since earnings.

In the long run, this strategy may bring more trouble than it is worth – something which may sour investors as the full effects become more evident.

First of all, if you’re going to pull away when reinsurance buyers need you the most, the relationships will pay the price when the business becomes more attractive. Secondly, casualty pricing may be a short-term gain while commercial pricing remains favorable, but narrowing appetite limits long-term growth opportunities.

In addition, Axis’s “win” this quarter is what many in the industry have been warning against – focusing on the underlying loss ratio and dismissing the impacts of catastrophe losses.

While improving its underlying loss ratio in the reinsurance segment over the past few years, the reported loss ratio remains elevated. For example, the chart below illustrates that while Axis and Everest Re have the lowest underlying loss ratios, the total loss ratios for the reinsurance segment are not.

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RenaissanceRe took a long view, betting on science and pricing.

The frequency and severity of weather losses can spook shareholders worse than the latest horror movie. RenRe is trying to keep those fears at bay.

While the industry has pointed to an increased frequency of weather-related catastrophe losses, RenRe is expressing more confidence in its modeling, and the likelihood of mean reversion. The firm noted that the last five years are just flipping tails five times in a row – not an indicator that the sixth flip will be another tail.

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The company has reiterated that rate increases are needed in property cat lines but is not stepping back. The potential pullback from other players, challenges for third party capital, and increased demand from primary carriers looking to limit volatility would support these rate increases and could leave RenRe better positioned.

The firm’s C-suite has also bought into its strategy – and put their money where their mouths are. Company leaders, including the CEO, CFO, CUO, chief accounting officer and group chief risk officer, all filed on Monday as publicly purchasing additional shares in the firm in transactions totaling more than $4.3mn.

This strong signal of faith in the direction of the firm is not seen that often in this industry where insider ownership has remained low relative to other sectors.

Everest Re presented a more balanced perspective.

Everest is focused on meeting its investor day targets of 13% shareholder returns in 2023, 10-15% top-line growth, and a 91-93% combined ratio. With these goals in mind, the company has been focused on diversification, highlighting growth opportunities in casualty lines and across its insurance business (GWP +43%).

Diversification for reinsurers is not a new concept. The cohort of reinsurers formed after 9/11 and 2005 hurricanes were forced to either consolidate or diversify as cat returns declined, and Everest Re seems to be betting on migrating its balance towards insurance over time. (In April, Andrade told Inside P&C's news team that Everest could double the size of its insurance business – already $3.2bn at that point – in the coming years.)

In its Q3 call comments, Everest Re walked the line between emphasizing it was no longer the cat heavy business it was in 2017, and stressing that cat remains a core part of its offering.

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In summary, each reinsurer is reacting differently to the challenges posed by several years of elevated catastrophe losses and inadequate pricing. Of the firms covered, RenRe may not have told investors what they wanted to hear at the moment, but its focus on longer-term positioning may yield results as the market shifts.

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