Changes to reinsurance-related capital requirements proposed by the Australian Prudential Regulation Authority (APRA) could support Australian general insurers' credit profiles over the medium term if they improve access to reinsurance protection, says Fitch Ratings.
However, catastrophe reinsurance pricing and the frequency, severity and cost of natural disasters will remain important factors in determining insurers’ willingness to take on reinsurance, and thus the long-term effect on their capital and earnings.
APRA launched consultations on planned reforms that would require general insurers to buy all-perils reinsurance coverage while lowering reinstatement requirements and removing the requirement to hold reinstatement premiums as part of the insurance concentration risk charge (ICRC). Any new standards would not come into effect until June 2026.
The initiative may be designed in part to encourage insurers to explore alternative reinsurance arrangements, such as catastrophe bonds and other insurance-linked securities – something APRA reminded insurers was possible in August 2023. Take-up for alternative reinsurance arrangements has so far been limited in Australia, despite a burgeoning global market. This may partly reflect the current regulations around reinstatement requirements for catastrophe reinsurance. Alternative reinsurance structures typically do not have such reinstatements, so APRA’s proposed lowering of reinstatement requirements could be favourable for this part of the sector.
Catastrophes
Fitch believes rising catastrophe reinsurance costs have contributed to insurers’ raising of their retention limits, increasing the exposure of their earnings and capital to such risk. Suncorp Group, for example, raised net retention under its main catastrophe reinsurance cover for the financial year ending June 2024, from A$250m to A$350m. It also opted not to renew its aggregate excess of loss reinsurance, a type of cover offering protection after an accumulation of smaller events.
The rise in catastrophe reinsurance costs has been driven mainly by the increased frequency and severity of extreme weather events. Lower reinstatement requirements should reduce costs but the aggregate impact of the proposals is unclear, as requiring all-perils reinsurance cover rather than named perils is likely to drive up costs.
Moreover, regulatory adjustments alone may be insufficient to reduce reinsurance costs if catastrophe losses borne by reinsurers continue to escalate. Capacity may also become a constraint – global reinsurers showed reduced appetite for all-perils cover during the 2023 renewals.
Factors influencing reinsurance usage
Insurers’ usage of reinsurance is also influenced by factors such as internal risk appetite and rating agency capital considerations. Where these are the main drivers of how much catastrophe risk is retained, APRA’s proposals may have less effect on retention rates.
APRA currently requires insurers to hold capital against a one-in-200-year loss, on a whole portfolio basis, with reinsurance protection up to this loss receiving capital credit. In New Zealand – a market dominated by subsidiaries of Australian insurers – reinsurance purchasing is driven by the Reserve Bank of New Zealand’s requirement to hold capital against a one-in-1,000-year earthquake event.
More reinsurance options would give insurers greater scope to manage their net exposure without greatly increasing net retentions and probable maximum loss (PML) values. This should support insurers’ credit profiles by helping them maintain net catastrophe exposure within manageable levels. Factors that help to avoid significant increases in net PML would support current rating levels.
Insurers could face a greater risk of negative capital and earnings effects if there are successive severe catastrophes (such as one-in-200-year losses), and they are not covered via reinstatements. Fitch believes this risk remains low. Such events should be extremely rare, though the changing frequency and severity of natural disasters underlines uncertainty over this assumption.