Climate change challenges insurance companies – 08/18/2023 – Market

With disasters intensifying like the wildfires that ravaged the Hawaiian town of Lahaina and storms that destroyed roofs from Alabama to Massachusetts last week, insurers stopped offering coverage in certain regions of the United States or reduced the types of damages for which repair will pay.

The shift has been driven by an often overlooked part of the financial industry, the reinsurance industry, which offers insurance to insurers.

The companies in the segment pledge to come up with money — often large sums — when something like a hurricane, wildfire or other major disaster creates damage that is too expensive and extensive for insurers to cover alone. At the beginning of the year, almost all of them raised prices.

In the weeks leading up to Jan. 1, the date by which about half of reinsurance policies are renewed for the year, reinsurance companies notified US and Canadian insurers—large national carriers such as State Farm and Farmers, even the smaller, more specialized companies—that their prices would rise. This led to a series of tense negotiations between these insurers and companies such as Swiss Re, Odyssey Re and other reinsurance companies, many of which are based outside the United States.

Reinsurance companies have lost money over the last four or five years as they compete to offer the best terms to customers, said Franklin Nutter, president of the Reinsurance Association of America, the trade association for reinsurance companies. But at the end of last year, they decided that competing this way wasn’t worth the cost.

“The reinsurance community as a whole essentially decided we needed a reset,” said Sean Kent, an insurance broker at FirstService Financial, which helps large home developments find homeowners insurance policies. “It was the most volatile reinsurance renewal date in decades.”

Rising prices for reinsurance companies have accelerated change in an industry struggling with a new sense of uncertainty. The world is warming up, storms are getting more intense, inflation has increased the cost of rebuilding after a disaster, and rising global interest rates are making money itself more expensive.

Since the start of the year, insurers have paid $40 billion to US customers, putting them on course for another year of record annual losses. At all levels, the cost of protecting against risk is rising, and everyone from corporate leaders to homeowners and small businesses is feeling the pinch.

“If you’re the CEO or CFO of a medium-sized company — say a real estate company that operates 500 homes in Minnesota — you’re going to be talking about reinsurance and the impact that reinsurance has on your bottom line and your profitability,” said Kent.

Reinsurance prices rose as much as 40% on Jan. 1 year-on-year, according to a report by Gallagher Re, a brokerage firm that brokers reinsurance cover arrangements. The price increases have shaken insurers, who have consequently changed their rules regarding places and beneficiaries to which they offer coverage.

When State Farm announced in May that it would stop accepting new applications for certain policies in California, it cited “a challenging reinsurance market.” Allstate also cited reinsurance costs when it suspended some of its California activities. Last month, reinsurance companies that specialize in crop insurance announced they were pulling out of Iowa, where, three years ago, a severe wind storm caused nearly $4 billion in damage.

As a result of rising reinsurance costs, insurers have also raised prices where regulation allows. According to Kent, the cost of insuring large new developments in wood-framed homes, the kind that are popping up around cities like Denver and Calgary, Canada, and on the Texas plains, has skyrocketed.

Severe storms in the United States caused nearly 70% of the losses that insurers worldwide suffered this year due to natural disasters, according to a report by Zurich-based reinsurer Swiss Re released on Aug. 9. And the weather is not likely to improve.

“2023 is very likely to be the costliest year on record for storms in the United States,” said Steve Bowen, Gallagher Re’s chief scientific officer.

For people outside the industry, it may seem strange that so many reinsurance companies, based in different parts of the world, behave in such a similar way. But in the insurance industry, the herd effect is common, according to Michael Powers, a professor of finance at Tsinghua University in China and a former deputy commissioner of insurance for the state of Pennsylvania.

“Industry people tend to be risk averse. They tend to look at the same data. They tend to see the world the same way,” Powers said.

Many industry experts, including Nutter, believe that reinsurance prices will remain high for a significant period. They say insurers may have to raise prices even in places where they encounter the most resistance from regulators, who generally review price increases for consumer insurance policies and have the right to block those they believe would generate excessive profits.

With the caution displayed by reinsurance companies, some insurers are turning to other methods to secure reserve money. One, the catastrophe bond market, allows investors to invest money that can be used to cover losses caused by major catastrophes in exchange for regular small payments, with an attractive return on investment. A record $7.1 billion in catastrophe bonds was issued during the second quarter of this year, according to Artemis, a company that tracks the bond market.

But not all reinsurance companies have pulled away from insurers in areas facing increased risks of natural disasters. The reinsurance business of Berkshire Hathaway, the conglomerate owned by Warren Buffett, recently entered into a $1 billion deal with Florida state insurer Citizens Property Insurance Corp. This is Citizens’ largest coverage arrangement to date with a single traditional reinsurance company.

Powers said that reinsurance prices could fall sooner than most people expect and that reinsurance companies will be on the sidelines for a little while before they start to feel like they are losing out.

“People realize that the sky hasn’t fallen,” he said, “and they want to make money.”

_{Translated by Paulo Migliacci}