Nothing Normal About “The New Normal”
“The new normal” is the phrase frequently used by insurance market commentators to describe the market conditions we operate in today. It’s as if we are witnessing fundamental secular or structural change in the business.
In my opinion, what we are actually experiencing is “a new abnormal” - a set of cyclical changes that will be followed by structural change. What’s abnormal about this soft market cycle is that it’s happening in a low/negative interest rate world. Meanwhile, continuing prior year positive loss reserve run-off is taking place during a prolonged period of benign catastrophe loss activity.
None of these factors are likely to persist for long, however.
The current interest rate environment can best be described as an experiment that’s made the insurance business attractive both as a direct investment and as a capital market investment.
Also, most of the favorable loss reserve development has come from the hard market accident years of 2002−2007. But reports of adverse development on the recent accident years, particularly in commercial lines, are starting to come through now.
Meanwhile, global property Cat loss experience has been abnormally low: it’s been 10 years since a destructive hurricane made landfall in Florida, the longest stretch since 1851.
All this talk of a “new normal” has led to some interesting spins on financial theory, with diversification frequently cited as strategy; pension fund investors in insurance-linked securities (ILS) often tout the non-correlation of ILS with other asset classes as a major attraction.
As evidence, they cite the short time that Cat bonds have been in existence. A better reference point will be a $100 billion or $200 billion catastrophe, after which the correlations with equities and fixed income investments will likely be close to one.
Proponents of the new hedge fund reinsurance model have been marketing its greater risk appetite in investment choices and a willingness to credit a greater portion of investment returns in pricing. But it’s a flawed model. The risk-free rate is the only appropriate discount rate to use: return above the risk-free rate compensates for the riskiness of the assets.
A strategy predicated on amassing float is not a sustainable business model. It is easy to generate float. However, it is very difficult to consistently produce low- or no-cost float.
Insurance is all about getting the right rate for exposure and uncertainty, not basing pricing on the experience of the last couple of years. And that isn’t always easy in a soft market dominated by brokers talking the pricing down, but it is our reality.
In five years’ time Gen Re will celebrate its 100th Anniversary, and in the case of our German subsidiary (former Cologne Re), it will be the 175th Anniversary. We will keep investing in the future. These are uncertain times, but with Gen Re you can be sure of one thing: our checks will clear after that $200 billion hurricane hits Florida.