Climate trends drive ‘underwriting performance volatility’ – AM Best

Ratings agency AM Best has maintained its outlook on the UK non-life insurance market as negative and offered a warning to the industry that there is a “growing risk of underwriting performance volatility”.

It explained: ”[The] negative outlook reflects economic pressures and the related challenges to underwriting performance. 

”Given that technical margings are already squeezed and reinsurance costs continue to rise, an increase in the weather-related losses could exacerbate the issues plaguing the UK non-life market.”

Expanding on the report in exclusive comments to Insurance Times, Valeria Ermakova, associate director for analytics at AM Best, said that the lack of stability in underwriting stemmed largely from a “changing frequency and intensity of weather-related events”.

In 2022, for example, the UK experienced its driest summer since 1995 – leading to a surge in subsidence claims that the ABI said equated to £219m in payouts.

UK non-life insurers were also affected by freezing conditions in December, which led to damage such as burst pipes and water tanks.

Given the common short-tail nature of property risks, Ermakova explained that insurers were generally able to adjust rates relatively quickly to accommodate any change in modelling outcomes driven by climate trends.

However, this is not always the case for casualty or financial risks cover.

Therefore, she said that it was “important for insurers to ensure they have a comprehensive reinsurance protection in place if necessary, so that companies’ capital is not eroded by excessive net exposure to weather-related losses”.

Reinsurance impact

Ermakova continued: “In this regard, a rise in weather-related events causing insurance losses may lead to a more limited availability of reinsurance protection, or an increase in its cost, as it could result in reinsurers reducing their capacity allocated to catastrophe risks and adjusting their rates.”

AM Best’s Market segment report, published last week (3 April 2023), further highlighted that there was a continuation in the hardening of reinsurance rates that took place across 2022 at 1 January 2023 reinsurance renewals.

Insurance Times has recently reported on the hardening of the reinsurance market, noting the potential of tough renewals to create knock-on impacts down the line.

The ratings agency said it was unlikely insurers would be able to pass on elevated costs to customers, due to a highly competitive market environment and inflationary pressures impacting buying behaviour.

It said the remaining options for insurers included reducing reinsurance cover and retaining more risk, or absorbing the cost – which could “further erode” underwriting margins already under pressure from inflation.

Sustaining shocks 

Echoing Ermakova’s sentiments, Michael Lawrence, distribution and underwriting director at LV Broker, explained that insurers would either need to “take a higher level of risk by having a higher reinsurance retention level or aggregate exposure” or, if a business “is not big enough to sustain those shocks”, it must “protect” itself with a lower level of retention and higher level of cover, which costs money.

“Trying to strike that balance at the moment is very difficult to predict,” added Lawrence.

“It depends on your appetite for risk [and] it depends on the size and strength of the organisation as to what you’re prepared to bare.” 

Lawrence further noted that reinsurers will be in the “same position”, due to challenges around determining whether last year’s adverse weather events will continue or whether they represented a “one in a 200-year event”, for example.

To mitigate the climate-driven “threat” to the non-life insurance market, Ermakova said: “What-if scenario testing using severe events in areas with concentrated exposures is crucial to understanding maximum potential loss and managing catastrophe risk.

“Companies also need to consider potential unmodelled scenarios in addition to model output to ensure that they are not overexposed to unforeseen events.

“AM Best would review the company’s resources and governance practices with regards to management of climate risk, in particular whether it factors climate trends into underwriting considerations – this can be done through risk selection, geocoding and other metrics to avoid areas subject to higher climate risk related severity.”

When looking at reinsurance, LV’s head of home underwriting Sam Dansey said that weather events must be considered globally and not just in the UK.