December 10, 2018 by Greg Meckbach
Reinsurance is extremely important but could get too expensive in certain areas, industry leaders said at a recent event.
Some insurance companies today are “dialing up their reinsurance protection – property and cat risk in particular in the United States,” Colm Holmes, president and chief executive officer of Aviva Canada, said Dec. 6 during a session at the KPMG Canada’s 27th annual Insurance Conference in Toronto.
But as interest rates rise, the insurance-linked securities market could shrink, Holmes said.
ILS refers to products such as catastrophe bonds. These let investors (such as hedge funds and pension funds) put money into a pool that insurers can use to reinsure a specific loss (United States wind storm for example). The downside for investors is they could lose all of the money they put it. But if the loss covered by the ILS does not occur, investors get their money back, plus interest at a rate higher than what would be available from conventional securities such as treasury bonds.
The growth of ILS has made reinsurance more available at cheaper rates. But the pace of growth of third-party capital for reinsurers is expected to slow, A.M. Best Company Inc. warned in Market Segment Outlook: Global Reinsurance, a report released Dec. 6.
“I think a lot of what is driving reinsurance costs is not actually insurance events but rather it’s interest rates and the lack of yield-enhancing investments that is pouring capital into those markets,” Holmes said Dec. 6 during the KPMG insurance conference at the Metro Toronto Convention Centre.
Interest rates are rising but have room to rise more.
The Bank of Canada overnight interest rate – currently at 1.75% – was 0.5% in mid 2017. This is down from 4.5% in 2007 and more than 20% in the summer of 1981.
If interest rates rise and investors move their money out of insurance-linked securities, “at that point the cost of reinsurance will potentially become prohibitively expensive in certain areas,” Holmes said. “What does that mean for provision of insurance in those markets? These are the things that we grapple with.”
Reinsurance was a topic for discussion at a separate KPMG conference session on regulation.
Reinsurance “will become even more important” with climate change, federal superintendent of financial institutions Jeremy Rudin said during a Q&A session with Chris Cornell, national sector leader for KPMG’s insurance practice in Canada.
“Through reinsurance you get access to wider a diversification pool so you can offer higher limits, you can insure different perils, you can [avoid betting] your entire company against an earthquake in one city. So it’s extremely important,” Rudin said.
Cornell had asked Rudin about the federal Office of the Superintendent of Financial Institutions’ ongoing reinsurance policy review. OSFI released a discussion paper on reinsurance regulation this past June.
OSFI “will be looking at changes” both to its reinsurance guidelines and to concentration limits, Rudin said.
Concentration risk refers to the risk to an insurer when it concentrates its reinsurance program with only a few reinsurers and one of them gets into financial trouble.
OSFI’s job is to protect clients by reducing the risk that an insurance company will under.