Financial Lines markets across Europe are experiencing rapid change as rates begin to taper off
From what I can see, the outlook for the Financial Lines market in Europe is changing, and changing quite quickly.
We are moving away from the hardening market experienced for the past two to three years and are starting to experience a degree of market softening since the latter part of last year.
Most prominent in my view is the cyber market with increased pricing competition from a variety of international insurers eager to capture a share of the growing European Cyber market.
That said, cyber coverage remains relatively stable with insurers still nervous about ransomware risk and at best, they start to introduce sub-limits for the more exposed cyber insurance covers.
Commercial D&O pricing is also flattening with a re-emerging demand for multi-year policies and a drop in the market submission flow indicating that policyholders can secure satisfactory terms with their incumbent insurers.
Claims frequency remains
One has to wonder if this apparent increase in market competition can be justified in light of the underlying market dynamics. In my view, current market behaviour is inconsistent with the broader economic picture.
Interest rates have been increasing for a while, meaning that the underlying risk capital providers - who ultimately support those insurance risks with their capital - will start to charge a higher cost of capital.
Insurance rates have been dropping too, meaning that the risk premium charged by those capital providers has to increase.
None of this seems to be reflected in today’s insurance risk pricing, except if one holds the view that during the past few years, insurers have been realising a large premium surplus.
The aggregate net premium received has been much higher than the incurred losses booked. This to me seems a rather reckless point of view knowing that Financial Lines are notorious for their long-tail loss development.
Based on our claims experience, I haven’t observed any reduction in claims frequency. Furthermore, one should prepare for a scenario where this premium surplus will be eaten away by rising inflation alone.
Aligning the interests of stakeholders
One explanation for this inconsistency in market behaviour and underlying economic developments may be the long chain of command in a traditional insurance company.
What top management preaches as the company’s underwriting mantra may not necessarily be the immediate message filtering down to the underwriting troops. The latter may be forced to go against their own company’s philosophy simply to deal with the pressure of having to meet the company’s annual budget, or more cynically, to optimise their personal compensation.
It takes time to align the top with the bottom of a large organisation. There’s a lot of - often unnecessary - plumbing between the two.
My personal view is that in the medium-term, there will be a market correction and the first signs of a changing market are already there. We see, for example, insurers creating side vehicles for cyber - trying to offload their cyber risk exposures in return for a risk-free management fee.
Another trend is insurers trying again to buy more reinsurance allowing them to increase the limits put on risk and maintain their premium income.
As a result of the specialty insurance industry consolidation over the past 15 years, aimed at building larger economies of scale and more stable underwriting profits, it’s also fair to say that reinsurers have lost market share and are keen to rebuild their aggregate risk exposure to the specialty insurance market.
Bidding for market share
It’s interesting to look at some of the larger global reinsurance companies who started building their own specialty insurance distribution network in Europe. I think that their recent European market entrance explains some of the more recent optimistic pricing behaviour observed in the European Financial Lines market.
They benefit from a fair amount of excess capital that they can easily deploy to build a quick European market share, at whatever risk pricing. Once they secure their market share, they will have the bargaining power to adjust their risk pricing if necessary.
It is certainly the case that policyholders have been looking for alternative insurance solutions for the past two years. We have seen the emergence of a European mutual for cyber risks, for example, similar to a Cat Nat or Terrorism pool.
Some policyholders decided to reduce their insurance limits or use their captives for part of the more difficult to place exposures.
Looking at the currently softening market conditions, I don’t think this trend will continue but rather stabilise. Insurance capacity is again flowing into the European specialty markets, easing the pressure to look for alternative risk solutions.
Differentiation and relevance are key
Where can one find opportunities in the midst of this softening financial lines market? Despite its recent pricing pressure, the cyber market continues its upward trajectory with this “El Dorado” of small to medium-sized first-time buyers still uncovered.
In this market environment, where differentiation and relevance are key, the future of MGAs looks bright too. Underwriting and operating margins will be squeezed, benefiting companies that are not hindered by their past legacy and can use new technology to operate and underwrite more efficiently and profitably.
Insurance capital providers will support this emerging European distribution model more and more often, allowing them to avoid the bloated fixed expense bases of traditional insurance companies whose strategic creativity often does not extend beyond the financial horizon of value-destroying M&A activities. Every cloud has a silver lining.
Gerard van Loon is CEO of Brussels-based Managing General Agent, Alta Signa
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