In my last post, I addressed the lack of sufficient catalysts to lead to a hard market rather than another false dawn. Today, I will lay out some events that could change that.
The fascinating thing about the insurance industry is we’re always one day away from a possible market turn. Just because I don’t think covid losses alone get us there, doesn’t mean we’re not closer than we were at the beginning of the year. Some of the necessary conditions are now in place.
The way I tend to think about it is along a spectrum. On the far left side is we need a mega cat tomorrow for a turn and on the far right side is reserves are awful, investment portfolios are a mess, balance sheets are overlevered, the government passed a new onerous regulation, and a Cat 5 is two days offshore from Florida.
Before covid, we were clearly past the halfway mark, call it 65%, but it was on a slow burn towards 100% given the gradual recognition of reserve deficiencies.
After covid, maybe it’s…70%??? There’s a good chance this is still only an average cat year (recall the global AAL is approaching $100B) and the pressure on reserves is temporarily forestalled by the decline in exposure and likely delay in the court process.
To give you a visual sense, if we use the Scoville heat chart below, we started the year at the Arbol pepper and have moved up to Cayenne.
So how do we get from Cayenne to pepper spray? Let’s consider some of the ways we could get there.
A Major Hurricane
This is the most obvious choice. Throw a $50-100B hurricane on top of the covid losses and things get hot! But Capsaicin hot? Eh, probably not. It would certainly put a flame under the cat market, but that takes us back to 2005, not 2002 or 1985. It’s unclear if cat, in and of itself, is enough to turn a market anymore.
A Regulatory Change
As I suggested in the prior post, if there are legislative changes that require forward pandemic coverage, that could be a game changer. Then, we have something analogous to being forced to write terror after 9/11 which could lead to significant capacity withdrawals and sufficient fear.
I will also reiterate that I don’t think insurers are giving proper attention to the pandemic risk from ongoing business. If a court strikes down an insurer’s form, but the decision doesn’t arrive until 2022, that means all of your 2H 20 and the full AY 21 are exposed to any second wave claims.
Agencies Move the Goal Post
One of the big drivers of the post KRW turn in cat was Best moving to the 1 in 100 capital test. Nothing like that seems imminent, but a changed ratings standard would certainly make capital more expensive.
Agency Downgrade Cycle
Similarly, we could see agencies get tougher on weaker markets and essentially pull A- capacity out of the market. There are a number of candidates who fit this description, but they are all smaller and would merely impact filling out a slip. They are not enough to turn a market. We would have to see a bigger company get in trouble.
A Company Failure
Could we have another Reliance? Anything’s possible. There aren’t any clear suspects, but there is certainly enough reserve pressure that it wouldn’t be totally shocking if a significant player is hiding a major reserve problem and is technically insolvent. The realization of that event would certainly move us up towards Habanero.
A Carrier Abandonment
This is different from a failure. In this case, I am referring to brokers and excess carriers refusing to support a wounded insurer. I will confess that the one time I bought into a false market turn was 09.
The combination of investment losses industry wide and stresses at major carriers (AIG, Hartford, Liberty, XL) should have produced a massive turn. I’m still stunned it didn’t happen. Clients should have asked for better paper and excess carriers should have demanded protections for writing above companies who were likely to compromise their underwriting to retain their market position.
None of this happened because Marsh and Aon convinced their clients not to switch and pressured the rest of the market into continuing to support towers. It was a big gamble by the brokers that worked out in the end, but could have easily gone the other way and resulted in massive E&O losses if AIG had failed.
Anyway, just as it is hard to see a company at risk of pulling a Reliance today, it is hard to envision a company that risks a collapse of confidence today.
Cyber or Electric Attack
If you’re one of the bad guys out there and you see how vulnerable our country is today, the most obvious way to attack is to take down the internet.
I don’t want to get too detailed with this (who knows maybe one of my readers is one of the bad guys!), but a large scale cyber attack or a simultaneous attack on multiple parts of the electric grid isn’t hard to envision. It’s honestly probably more likely than a global pandemic event.
If you want a never before seen hard market, that’s how you get one. Please be careful what you wish for!
I’m not sure I can envision what would trigger this (at least not in a way that doesn’t impact the rest of the industry), but if something came along that would lead Buffett to severely curtail new business that would prompt a turn.
Maybe he fears the accumulation of forward pandemic risk I mentioned? Maybe he finds a cheaper source of float than insurance? Maybe he loses a lot of $ on one of his other investments?
This certainly seems like a long shot, but I’m trying to be exhaustive here and not leave any options out.
I said I’m trying to be exhaustive! And, no, I don’t believe there are exclusions in most policies for an alien invasion. So, yes, if aliens invade, that would take things at least to Capsaicin and perhaps even hotter!
Assessing the Odds
I tried to rank these events from most to least likely obviously. However, the more likely ones also move the needle less than the remote ones. Realistically, I think it will take either adverse regulation or a major change by the rating agencies to get the market to turn in a meaningful away. That’s what I would keep my eye on if you’re trying to anticipate what comes next.