Opinion: Hurricane Ian Shows Why Cyber Reinsurers Should Have Bought ILWs Years Ago: Is It too Late?
By Tom Johansmeyer
Necessity may be the mother of invention, but after a hurricane, it can also create constraint.
The reinsurance market implications of Hurricane Ian are already significant, and we’re still early in the process of understanding the full scope of the event.
With the January 1, 2023 reinsurance renewal coming up quickly, it may be time to focus on some key challenges with the hope of accelerating some of the storm’s potentially enduring lessons.
For the cyber market, that means taking a critical look at capital sources and how to diversify them in the future.
Based on PCS client conversations, Hurricane Ian is likely to have an uneven impact on the global reinsurance industry. However, trapped collateral in the insurance linked securities sector (ILS) and concerns about loss creep among even larger reinsurers – coupled with uncertainty about loss creep from the conflict in Ukraine and potential aviation losses from aircraft still in Russia – is likely to result in some changes in how capital is allocated at the upcoming reinsurance renewal.
For the cyber sector, this could be particularly problematic. In addition to being a smaller and more volatile line of business, geopolitical uncertainty had already cast a bit of a shadow over the segment.
The real problem, though, is likely to be reinsurance rates.
Many expect further hardening of property-catastrophe reinsurance rates at the renewal, and although cyber reinsurance rates have certainly increased over the past several years, the sense is that property-catastrophe business will provide more potential.
If the reinsurance industry does veer to a “go with what you know approach” with a sector poised to deliver greater returns anyway, then there is the possibility that some could withdraw capacity from the cyber reinsurance market, insist on even higher rate increases despite what some say has been a fairly quiet year, or both.
As a result, cyber reinsurance buyers could face an exacerbated shortfall of capacity in 2023, following several consecutive years of insufficient cyber reinsurance supply already.
The prospect of turning to the capital markets – frequently discussed for at least five years with little in the way of action – would seem promising in different circumstances.
Unfortunately, the ILS market has to contend with Hurricane Ian as well, and even if much of the capital currently trapped is released over the coming months, competition for it will be stiff, given the anticipated needs of the property-catastrophe sector.
While it may be too late for an easy win with the ILS market, it’s still too soon to abandon hope.
The temptation during a capital squeeze is to settle for nothing less than a full solution to the problem at hand, and in the end, that approach likely won’t yield much.
Instead, now is the time for discipline, patience, and focus. Of course, that’s a lot to ask, but it’s worth it.
Given the tightness expected across the reinsurance and ILS markets, engaging in smaller ILW transactions now, to understand the process and help establish a more robust market, could result in the development of a more robust and reliable market.
Getting out and completing high-attaching cyber catastrophe ILWs for small notional limits may be enough to get the market comfortable with the concept, help trading partners achieve clearing prices, and establish some benchmarks.
With small trades, quite literally, there is typically much less to lose. And the lesson, while potentially costly, is generally still more contained than the traditional method of taking a small line on a traditional reinsurance program, a lesson that often comes with both financial commitment, deal complexity, and a range of hidden frictional costs associated with administering such a treaty (e.g., reserving).
Based on market sentiment and patterns PCS has seen in the adoption of other new index products over the past five years, initial proof of concept trades tend to lead to robust trading markets fairly quickly.
The first PCS Global Marine and Energy ILW in 2017 was followed by several more in fairly short order, not to mention ongoing use from the January 1, 2018 reinsurance renewal.
Early trading in PCS Japan in the second quarter of 2019 began a year in which more than $700m in limit was traded.
Use of PCS Global Cyber seems likely to follow that pattern.
Cyber ILW proof of concept transactions in 2018 or 2019 likely would have led to capital availability today, even in the face of an event as significant as Hurricane Ian. But, they didn’t come.
The implications are evident today. Now, the only question that remains is whether our market will allow history to repeat itself.
Tom Johansmeyer leads PCS at data/analytics firm Verisk