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2 Reinsurance Market Outlook

Contents

Executive Summary: Value Remains as Market Evolves 3

Global Reinsurer Capital 4

Demand Upticks Slightly Following COVID Uncertainty 9

Rating Agency and Regulatory Updates 13

North American Natural Perils Dominate 2020 YTD Global Natural Peril Losses 15

More Data and Retained Catastrophe Losses Make A Custom View Highly Beneficial 16

Forecasters: Extremely Active 2020 Atlantic Hurricane Season 24

Contact Information 25


Executive Summary: Value Remains as Market Evolves Even as markets continue to evolve in the wake of COVID-19, reinsurance remains an accretive form of capital for insurers in managing volatility. Increased risk transfer over the last six months has demonstrated the value reinsurance provides to actively trade risks in the market. Headwinds for the industry include evolution of COVID-19 related losses and coverage as well as trends that were emerging prior to the pandemic including reinsurer combined ratio results, social inflation, catastrophe loss experience driven by more secondary perils, and low interest rates. Despite these challenges, the market has also seen counterbalancing impacts that affect financials, but also the markets ability to operate. These include rebounding global reinsurance capital through Q2, capital raises of circa USD8 billion supporting traditional capital, quick adaption to virtual working environments, continued adoption of efficient technology and risk transfer platforms, and a relatively well-connected industry. These factors have preserved the ability to match capital with desired risk transfer and we expect these trends to continue for upcoming January renewals.

Throughout the last six months, some global insurers were able to effectively increase property catastrophe risk transfer to mitigate further impact of COVID-19 losses and peak zone capacity renewed in a relatively orderly fashion during the spring. Should these dynamics persist, slight increases in demand are expected for property catastrophe through January renewals as insurers face a heightened view of risk and volatility, and pressures from rating agencies. More broadly than catastrophe risk, industry reserve dynamics and recent rate increases also suggest potential increased demand albeit balanced with the need to meet positive risk transfer metrics for insurers who can retain the risk if they fall out of line. Undoubtedly, cedents able to articulate portfolio impacts of COVID-19 not only from losses but changing primary market trends will be best positioned for renewals.

Global reinsurance capital increased through Q2 ending the quarter just 2 percent below year end 2019 at USD 610 billion, despite a fall to USD590 billion at the end of Q1. Combined with new issuances, traditional reinsurance capital now stands at USD519 billion. While alternative capital remains impacted by trapped capital from historical losses, the diversification aspect of reinsurance risk continues to draw investors and remains a significant portion (circa 15 percent) of global reinsurance capital for the market ending Q2 at approximately USD 91 billion.

To date, insured global catastrophe losses stand at USD54 billion for the year; below full year 2019 estimates of USD75 billion. That said, more than 60 percent of 2020 insured losses have been caused by secondary perils and eight of the last ten years have seen higher economic losses from secondary perils than primary perils. These industry trends coupled with higher quality claims information demonstrate the need to better harness data and analytics, and develop custom views of insurer risk that can further improve the ability to trade catastrophe risk.

Note: This reinsurance market outlook report should be read in conjunction with our firm’s views on rate on line, capacity and retention changes for each cedent’s market. Our professionals are prepared to discuss variations from our market sector outlook that apply to individual programs due to established trading relationships, capacity needs, loss experience, exposure management, data quality, model fitness, expiring margins and other factors that may cause variations from our reinsurance market outlook.


Global Reinsurer Capital Capital market rebound drives recovery in Q2 2020 Aon estimates that global reinsurer capital dipped to USD590 billion at March 31, 2020, before recovering to USD610 billion at June 30, 2020. The reduction over the first half of the year was relatively modest at 2 percent. This calculation is a broad measure of the capital available for insurers to trade risk.

Exhibit 1: Global Reinsurer Capital

Sources: Company financial statements / Aon Business Intelligence / Aon Securities Inc.

Traditional equity capital fell by 2 percent to USD519 billion over the six months to June 30, 2020, aided by a capital market rebound in the second quarter and around USD8.0 billion of new issuance. The total is little changed relative to the end of 2016, partly reflecting the impact of natural catastrophe losses in the intervening period. Risk-based capital adequacy has declined as a result, but solvency ratios generally remain comfortable across the reinsurance sector.

Assets under management in the alternative capital sector are estimated to have fallen by 4 percent to USD91 billion over the six months to June 30, 2020. Some of the assets supporting collateralized reinsurance contracts have been trapped, due to the ongoing uncertainty surrounding the ultimate extent of recent major losses, now including COVID-19. As a result, the funds available for deployment are somewhat lower than the headline total would suggest, a phenomenon which is impacting the retrocessional market in particular.

Macro impact of COVID-19 The effects of COVID-19 are ongoing and the full extent of the economic damage is becoming increasingly apparent as direct government support is gradually withdrawn. At the same time, current news-flow around the pandemic is far from positive and the potential for further periods of lockdown clearly exists.


Against this backdrop, the extent of the stock market recovery has been quite remarkable, particularly in the U.S., where the S&P 500 and Nasdaq indices have returned to all-time highs. It remains to be seen whether this performance can be sustained to the year-end, particularly with the wildcard of a U.S. election in early November. The insurance and reinsurance sectors continue to lag, as shown in Exhibit 2.

Exhibit 2: Indexed Share Price Performance in 2020

Source: Bloomberg and Aon; all data at August 31, 2020

Traditional capital

COVID-19 has already undermined reinsurance sector earnings for 2020. The 23 companies forming Aon’s Reinsurance Aggregate (the ARA) reported a net loss of USD1.1 billion for the first half of the year. The P&C combined ratio stood at 104.1 percent, including a contribution of 9.7 percentage points from USD8.2 billion of COVID-19 related losses, the bulk of which are incurred but not reported at this stage. Another USD1.0 billion of losses were reported on the life side. The total investment yield declined to 2.1 percent, the weakest result since the financial crisis.


Exhibit 3: Reinsurer Results*

Source: Company financial statements / Aon Business Intelligence

* Based on Aon’s Reinsurance Aggregate

Total ARA capital (equity and debt) was unchanged over the first half of 2020 at USD255 billion. Total COVID-19 related losses of USD9.2 billion pre-tax represented 4.5 percent of opening total equity of USD203 billion. The distribution across the ARA companies is shown below.

Exhibit 4: Reported COVID-19 Losses as % of Total Equity at December 31, 2019

Source: Company financial statements / Aon Business Intelligence


Given that the effects of COVID-19 are still ongoing, related claims will likely represent a drag on reported earnings for some time. Results for the third quarter of 2020 will also show the effect of numerous large losses, most notably Hurricane Laura. On the plus side, the benefit of improved pricing is beginning to feed through and capital market conditions have generally been favorable since June 30.

Alternative capital Recent years have represented a significant test of investor appetite for insurance risk. Many supporters of sidecars and collateralized reinsurance transactions have experienced significant losses, with returns further diluted by the trapping of collateral. Concerns around model credibility, loss creep, and climate change have caused some to leave and others to pause, resulting in an overall reduction in assets under management.

Some new inflows of alternative capital have been seen, but they have tended to favor established managers with strong track records. The perceived lack of correlation with broader capital markets remains the main driver, with the expectation of higher returns now added to the mix. However, this rationale may begin to be challenged if investors see additional collateral becoming trapped because of COVID-19.

Exhibit 4: Alternative Capital Deployment

Source: Aon Securities Inc. One bright spot is the property catastrophe bond market, where the liquidity of the product and the peril-specific nature of the coverage continues to attract strong interest. Around USD6.5 billion of limit was placed in the first half of 2020, nearly matching the maturities. Total limit outstanding stood at USD28.4 billion at June 30, 2020.


Exhibit 5: Property Cat Bond Issuance

Source: Aon Securities Inc.

Capacity outlook Reinsurers entered 2020 with a need to improve earnings, but facing several headwinds, notably declining interest rates, elevated reserving risk (‘social inflation’ and deteriorating major losses), and rising retrocession costs. Consequently, Aon’s January forecast that a modest tightening of reinsurance capacity would be observed as the year progressed.

COVID-19 has since exacerbated many of the pressures that were already existing in the market. Negative effects on both sides of the balance sheet will likely result in the sector failing to cover its cost of capital in 2020. Furthermore, interest rates have been slashed in response to the pandemic, considerable uncertainty remains around the ultimate extent and distribution of related claims and additional collateral will be trapped as a result.

The more difficult operating environment has resulted in financial strength ratings coming under pressure in 2020, despite the resilience of the capital base. Negative rating actions have tended to correlate strongly with recent under-performance on the underwriting side and are expected to reinforce discipline going forward.

The mid-year renewals confirmed the expected tightening of reinsurance capacity and the current dynamics will likely remain in play at January 1, mitigated to some extent by the entry of new capital. Certain downside risks must also be acknowledged, notably the potential for further major natural catastrophe losses and/or COVID-19 related capital market volatility between now and the year end. Set against this, the capitalization of the reinsurance sector remains a clear strength.


Demand Upticks Slightly Following COVID Uncertainty New views of risk and the ability to readily transfer certain types of volatility, served to increase reinsurance demand during the last six months and we expect this trend to continue. The following summary notes a few of the industry capital management trends impacting reinsurance demand for the near future.

Topic / Issue Impact Commentary Heightened view of risk and volatility

Increase COVID-19 losses and its impact on investment market volatility and the global economy have highlighted how interrelated risks can be, especially under stress events. Couple this with growing concerns related to climate change, we see risk managers evolving their view of ‘tail risk’ scenarios. In general, these are resulting in a view of increased frequency of high severity, stress scenario events. As such, we have seen increased demand to mitigate tail risk from catastrophe events as well as from potential loss development on legacy reserves via adverse development covers. At the same time, a growing number of “mini-cats” from secondary perils have eroded underwriting results and we have seen insurers shift toward earnings protections. Lastly, as we near the upcoming U.S. presidential election and potential change of party in power, we expect market volatility to return as speculation grows. It is noteworthy to mention that any future change in U.S. tax reform will impact insurer balance sheet through restating deferred tax assets or liabilities.

Increasing rating agency pressure

Slight Increase

Following the outbreak of the coronavirus pandemic rating agencies changed numerous sector outlooks to negative. Most notably, the global reinsurance sector was revised to negative by Fitch and S&P, AM Best and Fitch revised U.S. Commercial sector to negative, and AM Best, Fitch and Moody’s revised the outlook on U.S. Life & Annuity to negative. Overall, Fitch was the most active revising insurance sector outlooks to negative. In addition, the rating agencies introduced “pandemic’ scenario stress test on capital adequacy. The stress test is heavily asset-focused from investment volatility from the pandemic and generally impacted Life & Annuity insurers more than non-Life insurers. While the market has fully rebounded since March, the stress test provides new thresholds for insurers to consider, which may be modified depending upon how COVID-19 losses develop.

Improved rate environment attracting capital

Increase Commercial and reinsurance rates have been improving throughout 2020, which has led to significant capital inflow. We estimate that approximately $8 billion has been raised since March to support insurance capital, with around 80% focused on offensive / growth strategies. In addition, there are several new company formations in the works that will push the total capital raise above $10 billion. The increasing rate environment and new entrants in the market will feed demand for reinsurance. At the same, the growth in fronting companies and their opportunities in the market are providing another source of reinsurance demand. While reinsurance rates may feel some pressure, it remains an effective and cost-efficient source of capital.


Captives increased focus on capital management

Slight Increase

A recent AM Best report noted captives are positioned to grow significantly given changes in market terms and conditions as well as reduced capacity for certain lines of business. Rated captives have used reinsurance to manage rating agency tail risk scenarios and increasing utilization of the captive will lead to increased reinsurance demand. At the same time, captive risk managers and sponsor-entity CFOs for unrated captive are re-evaluating captive capital requirements, including increased use of reinsurance, to afford greater flexibility to the ultimate parent. This demand will be somewhat tempered by business no longer flowing to the traditional market, which contributes to reinsurance demand.

Industry Reserve Trends Suggest Increased Need for Volatility Transfer Booked industry aggregate net reserves were essentially flat from year end 2018 (USD637 billion) to year end 2019 (USD638 billion). Also, during 2019, net aggregate calendar year incurred losses benefited from USD6 billion of favorable development of prior accident years.

In an assessment of reserve adequacy, the industry aggregate deteriorated during calendar 2019. Deficiency of USD 2 billion estimated at year end 2018 slipped to a deficiency of USD4 billion at year end 2019. The deficiency in commercial lines has grown from USD9 billion at year end 2018 to USD14 billion at year end 2019. The offset from the redundancies in personal lines has also grown during 2019 but with less magnitude (USD7 billion redundancy at year end 2018 to USD10 billion redundancy at year end 2019).

Separately, for various casualty lines there is some empirical evidence of claims closing at sustained elevated severities in recent calendar years. The impact of these current calendar year severity trends may not be fully contemplated in booked reserve levels which consequently increases uncertainty around these reserve levels.

Exhibit 7: Commercial Auto: Paid Severity on Closed Claims

Source: Annual Statements

8%

0%

-2%

10%

5%4%

0%

6%5%

7%6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Sample


Perhaps not unrelated, Aon has observed an increased interest in retroactive reinsurance products to cover prior year reserves along with a growth in reinsurer capital dedicated to the retroactive reinsurance market. This trend has been increasing steadily over the last 18-24 months and looks to continue for the near future.

U.S. Primary Rate Change Rates continue to increase for many major lines in the United States. Commercial auto and commercial property saw rate increases in line with the prior quarter of over 10 percent, on average. General liability increased again for the quarter at over 7 percent, a trend that started above 5 percent in Q2 2019. Umbrella followed a Q1 trend increasing more than 22 percent on top of smaller rate increases in 2019. Workers’ compensation saw the first positive average rate increase per quarter of 0.8 percent since 2014.

Exhibit 8: U.S. Rate Change by Line of Business

Source: Council of Insurance Agents and Brokers

50%70%90%

110%130%150%170%190%210%230%250%

Commercial Auto Commercial Property General Liability

Umbrella Workers' Comp


Premium Cessions As A Percent of GWP Increase, Driven By Casualty Overall, premium cessions for the U.S. continue to increase, driven largely by the percentage of premium ceded for casualty lines, up to 5.9% compared 5.4% in 2018. Nominal dollars of ceded premium increased by over 15 percent for casualty, combined property and casualty over 10 percent and property and specialty circa 5 percent. By comparison, GWP (ex-assumed) increased approximately 5 percent.

Exhibit 9: U.S. Ceded Premium to Non-Affiliates as a percentage of GWP

Source: S&P Market Intelligence

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

2000 2002 2004 2007 2009 2011 2013 2015 2017 2019

Property Casualty Property & Casualty Specialty


Rating Agency and Regulatory Updates Rating Agency Hot Topics COVID-19 Impact: Due to the coronavirus pandemic there have been many revisions made to industry outlooks by rating agencies. The pandemic causing an increase in claims is seen as a secondary issue to the broader impact of economic slowdown, declining interest rates and equity valuation. Many rating agencies developed COVID-19 stress tests as early as March to test how life & health, P&C, and reinsurance companies’ balance sheets may handle the pandemic and a sustained economic slowdown. In some countries, regulatory updates have been placed on hold, and only items directly impacted by COVID-19 have transpired.

U.S. Outlooks

Sector AM Best Fitch Moody’s S&P Commercial Negative Negative Stable Stable Personal Stable Negative Stable Stable Global Reinsurance

Stable Negative Stable Negative

Life & Annuity Negative Negative Negative Stable Health Stable Negative Stable Stable

*Sectors in this table are for the U.S. except for Reinsurance, which is Global

AM Best’s COVID-19 stress test resulted in most regions/sectors BCAR scores drop modestly at the VaR 99.6 with no change in BCAR assessment due to the stress test. Only 2 percent of U.S. & Canadian P&C companies saw a drop in BCAR assessment of 2 or more levels. However, 32 percent of U.S. & Canadian Life & Health insurers showed a significant decline in BCAR of 2 or more levels. AM Best concluded that the pandemic will likely be a 2020 earnings event rather than an erosion of insurers’ risk-adjusted capitalization.

During the first half of 2020, S&P took negative rating action on 9 percent of the rated insurers globally compared to 40 percent for the broader corporate universe. This divergence is attributable to the high creditworthiness of the insurance sector. COVID-19 related rating actions by S&P were typically driven by of one of three factors: Negative rating actions on the sovereign impacted insurers’ ratings. This was particularly the case

with Latin America, where sovereigns constrain/pressure insurers ratings.

Negative ratings actions based on the expectations that weaker profitability coupled with volatility in the financial markets will erode prospective capital adequacy. This was particularly the case with the reinsurers, APAC life companies and the targeted actions on other companies where these factors exacerbated existing weaknesses.

The expectation that mortgage delinquencies will increase substantially drove negative rating actions on North American and Australian mortgage insurers.


Fitch performed a stress-case coronavirus review, with the following insurance rating actions were taken globally:

177 ratings were affirmed with no rating action or change in outlook

Some negative rating actions were taken due to the coronavirus review, including

– 38 ratings affirmed with a negative outlook

– 5 ratings affirmed with a negative rating watch

– 6 single-notch downgrades

Innovation: AM Best’s final innovation criteria took effect in March 2020. There has been no significant impact to ratings based on the implementation. AM Best anticipates the innovation assessment to have a larger impact on companies’ ratings as time progresses, highlighting the importance for companies to continue to innovate and adapt. This will be especially important as the insurance industry and all underlying industries it serves begins to adjust to a post-COVID world. Rating agencies and regulators will be looking for insurers that can innovate through the change.

Regulatory Updates The NAIC Credit for Reinsurance Model Law (#785) and Model Regulation (#786) strengthen state regulation, prevent regulatory arbitrage, protect U.S. policyholders, and reduce the uncertainty faced by insurers when planning for collateral liability. The 2019 revisions implement the reinsurance collateral provisions of the Covered Agreements that were entered between the United States, the European Union and the United Kingdom, which require states to eliminate collateral requirements entirely within 5 years or be subject to federal preemption. In June 2019, the NAIC adopted revisions to the models that are intended to implement the reinsurance collateral provisions of the Covered Agreements. Six jurisdictions have adopted the 2019 revision, and 20 have the action under consideration (as of April 30, 2020).

This law also requires that a domestic ceding insurer shall notify the commissioner within thirty (30) days after reinsurance recoverable from any single assuming insurer, or group of affiliated assuming insurers, exceeds fifty percent (50%) of the domestic ceding insurer’s last reported surplus to policyholders or more than twenty percent (20%) of the ceding insurer’s gross written premium in the prior calendar year.


North American Natural Perils Dominate 2020 YTD Global Natural Peril Losses The combination of a series of notable natural catastrophe events during the first half of Q3, in addition to the continued evolution of loss estimates from Q1/Q2 2020 events, has resulted in private and public insurance entity payouts increasing as Q3 moves forward. Global insured losses have risen to USD54 billion. While still below the USD75 billion incurred in 2019, the Atlantic Hurricane Season has already produced a record number of storms to-date and the California wildfire season is off to a destructive start. Large events thus far in 2020 have also shown prolonged loss development as the COVID-19 environment has forced a change in how damage assessments are conducted and the speed by which claims are approved / paid.

Exhibit 10: Global Insured Losses by Peril

Source: Aon Catastrophe Insight

Through the first eight months of 2020, the severe convective storm (SCS) peril – USD32 billion – remains the costliest globally and accounts for nearly 60 percent of insured losses. Most of those losses occurred in the United States following what has been a very active spring and summer for tornadoes, large hail, and damaging straight-line winds. SCS losses for U.S. insurers have topped USD10 billion in insured losses every year since 2008, with 2020 marking the 13th consecutive year. Through the middle of Q3 2020, there have been 14 individual billion-dollar insured loss events. All but two were in the United States, and 11 of the 14 globally were spawned by severe convective storms. The other three include two tropical cyclones (Hurricanes Isaias and Laura in the U.S.) and Europe’s Windstorm Ciara.

This preliminary data comes via Aon’s Catastrophe Insight group, which is part of Impact Forecasting. To view the most up-to-date catastrophe loss data, please visit: http://catastropheinsight.aon.com

http://catastropheinsight.aon.com/


More Data and Retained Catastrophe Losses Make A Custom View Highly Beneficial The insurance industry largely relies on catastrophe models to provide a robust method of risk accumulation to quantify extreme, yet plausible loss potential from catastrophic events. Outputs from catastrophe models, including their measurements of expected loss and volatility have become common currency in catastrophe reinsurance placements, with just a few vendors being relied upon globally. However, inherent with models is considerable uncertainty that is not always well understood by the stakeholders who rely on modeled loss estimates to make business decisions.

To fully capitalize on the many benefits of catastrophe models, it is essential that insurers take ownership in understanding the inherent assumptions in the models and how they interact with each insurer’s unique exposure profile. In conjunction with catastrophe risk modeling and management, Aon believes a new risk has emerged, ‘model risk’. Model risk is the dependence on a 3rd party model vendor to measure and effectively manage your catastrophe risk. This implies that a change, either to a new version or to an alternative model vendor could cause a significant disruption to business. Insurers may be tied to the loss estimates provided by a vendor and / or to its underlying platform to manage catastrophe exposure. Model risk can be mitigated by having a customized view, including the use of adjustments to vendor models when appropriate.

Models are often calibrated to an industry view and are informed by limited claims experience. Since there is incomplete data, engineering and scientific judgement are often used to define event parameters such as hazard, frequency, severity and the vulnerability of exposure. Differences in model methodology, approach, and in the corresponding loss estimates across vendors demonstrate the uncertainty and range of reasonable outcomes in modeled loss estimates. In many cases, there is convergence in industry modeled loss across vendors for key peril regions such as US hurricane where there is a plethora of claims data and a well catalogued database of historical event parameters. However, even for this key peril, we continue to see sizeable differences in loss estimates across vendors for some geographic areas and classes of business. An evaluation, or ‘deep-dive’ into the assumptions used by each vendor, can explain differences across model vendors and identify model strengths and weaknesses.

Model Risk: Dependence on a 3rd party model

vendor to measure and effectively manage your

catastrophe risk.


Insurers writing unique lines of business or whose underwriting strategy makes their book of business distinct from the industry may not be well served with an ‘out of box’ unadjusted model view. Additionally, there are several contributors to loss that are not explicitly considered such as loss adjustment expenses and flooding (in some regions). There has been increased interest by regulators on model validation. As an example, Lloyd’s Cat Risk Operating Framework (CROF) model encourages full model validation and a bespoke view of risk approach for Syndicates.

Insurers who own their view of risk can manage their dependence on model vendors to define this for them, ensure models are used consistently across their business, and have greater confidence in their cat risk tolerance thresholds. A bespoke view of risk that is explainable and defensible can be used to manage your portfolio and in risk transfer. Aon engages with clients to customize their View of Risk; our framework can be used to evaluate catastrophe models and develop and operationalize a customized view of risk for your firm through these steps: Evaluation, Customization, Education, and Integration.

A Spotlight on Secondary Perils

Secondary Perils: A Greater Portion of Annual Loss While tropical cyclones often attract most focus given the high financial toll that landfalling events can incur, losses from “secondary” perils cannot and should not be ignored. While individual financial losses (economic or insured) from severe convective storm, flooding, wildfire, winter weather, European windstorm, and drought may not frequently carry the big dollar signs that hurricane events have the potential to carry (e.g., insured losses from landfalling tropical cyclones that exceed USD10 billion such as Katrina, Sandy, Irma, Andrew, Jebi, etc.), but individual event losses can still be significant and the accumulation of smaller losses has the potential to cause notable challenges for re/insurers.

“If you use a model which you have not performed due diligence

on, you are effectively ceding responsibility for the risk

management and capital structure of your organization to the model provider.” Ian Branagan, CRO,

Renaissance Re


Despite the United States often driving a significant portion of insurance-related losses in any given year, the relationship around primary and secondary perils is more evenly spread on a global basis when looking at the overall economic damage costs. In fact, when analyzing global economic losses, eight of the past ten years have featured secondary perils aggregating to higher financial costs than primary perils globally. Only 2011 (major earthquakes in Japan and New Zealand) and 2017 (Hurricanes Harvey, Irma, and Maria) featured tropical cyclone and earthquake damage costs that surpassed the secondary ones.

One country beyond the U.S. which has faced more dominance from secondary perils is Australia. In fact, more than 74 percent of aggregated losses since 1967 have come from severe convective storms (notably hail), inland flooding, bushfires, and non-tropical systems known as “East Coast Lows”. Primary (tropical cyclone and earthquake) perils only account for 26 percent. In addition to accounting for most aggregate losses, six of the top 10 event losses in Australia are also a result of secondary perils. The 1999 Sydney hailstorm remains the most expensive event for the Australian insurance industry on a normalized basis. The Southern Hemisphere summer of 2019/20 resulted in the costliest bushfire season in Australia’s history after more than 10 million hectares (25 million acres) – equal to 8 percent of Australia’s total vegetation – with insured losses surpassing AUD2.3 billion (USD1.68 billion).

Exhibit 11: Global Primary and Secondary Perils


The magnitude and consistency of losses from secondary perils makes it clear that properly understanding and managing the risk is an important key to controlling loss volatility and protecting earnings. To do this, however, the right tools must be in place. An interesting observation from the modeling perspective is the disconnect between insurance penetration for individual secondary perils and industry investment in analytics tools to support those perils. A deeper look at severe convective storm, inland flood, and wildfire below.


Severe Convective Storm While tropical cyclones remain the costliest peril for the insurance industry in the United States, the gap between the peril and number two on the list, the severe convective storm (SCS) peril, is not as significant as one might generally assume. Since 1990, tropical cyclones have triggered USD362 billion in cumulative losses by public and private insurers by comparison to SCS at USD330 billion.

Exhibit 12: United States Insured Loss



There is a striking difference in the behavior of tropical cyclone and SCS losses in the United States on an annual basis. While tropical cyclone losses show significant volatility on an annual basis – especially in high-loss years such as 2004, 2005, 2008, 2012, 2017 – there is almost complete linearity of the SCS trend. This trend has accelerated since 2008, which began a “new normal” of insurers regularly citing more than USD10 billion in annual payout. Some years, including 2011, 2017, 2019, and 2020, have resulted in losses topping USD20 billion. An increased frequency of events with losses topping USD500 million or USD1 billion has led to aggregation that often surpass yearly hurricane-related totals if Atlantic seasons are meteorologically quiet.

Through the end of August 2020, the U.S. had already recorded 10 individual billion-dollar SCS events for the insurance industry. This is the highest such number on record, even surpassing the eight in 2011. Particularly of note, the August 10 derecho event which caused extensive and substantial straight-line wind damage to property and agriculture across Iowa and Illinois was poised to be one of the most expensive non-tornado driven events on record for the peril in the U.S. or globally. See the next page for a graphic highlighting billion-dollar insured loss events by secondary peril dating to 1990 in the U.S.

As these small and medium-sized SCS events continue to occur with more frequency, this is likely to enhance the usage of Aggregate Excess of Loss Reinsurance as a safe form of cover. Such a solution is an effective way for insurers and the broader industry to handle increased payouts given a higher number of occurrence events and changes in event severity. As these types of events end up producing losses that are typically retained by the insurers and not heavily ceded to reinsurers / alternative markets, these events do not broadly influence reinsurance pricing changes – save for those regional or single state insurers that do see losses reach into their reinsurance program. These events do lead to a more substantial impact on quarterly earnings. The current availability of excess capital in the reinsurance market continues to reinforce that it is well-positioned to handle more of these types of events, and multiple larger scale and costly natural perils. Analytics support for placement of an aggregate treaty has largely been dependent on experience data for the SCS peril, but in absence of robust data, additional solutions are required.

Exhibit 13: Secondary Perils, U.S. Billion-Dollar Insured Loss Events



And despite the eye-opening trends and needs of the marketplace, the tools that are available to manage this risk tend to be older and often underestimate risk (and thus may not be widely embraced by the industry). It is recognized that SCS is a tough peril to ‘get right’ due to challenges with observation data (population bias for storm reports) for understanding hazard and widely recognized issues with fraud leading to inflation of losses, which leads to challenges for “nailing down” the vulnerability. In fact, some insurance companies choose not to provide SCS modeled losses to markets as they do not believe the models adequately reflect their portfolio experience. That said, more investment and effort in this area is needed for a wide range of use cases, from tools to assist in more risk-informed underwriting for this peril to more widely embraced solutions for managing portfolio event loss volatility and surplus erosion.

Aon, in partnership with Athenium Analytics, is working to create a better foundation of knowledge of the SCS peril, including the sub-perils of hail, straight-line winds, and tornado. Athenium Analytics boasts a team of meteorologists, engineers, and data scientists that are skilled at processing data ranging from human-observed SCS data sources to radar-derived datasets to more accurately capture historical hazard data. Athenium and Aon will collaborate to ensure that hazard is appropriately captured across the continental US (minimize population bias) and work together to ensure proper de-biasing and de-trending of the data. The robust historical data will then serve as the foundation for a new stochastic event set to be implemented within Impact Forecasting’s SCS model.

Inland Flood The observations around U.S. inland flood are entirely different than SCS. New underwriting and portfolio modeling solutions are entering the market consistently and existing analytics solutions are rapidly evolving; investment in inland flood is certainly not lacking. What is lacking, however, is insurance penetration in the U.S. A notable protection gap still exists for this peril, particularly on the residential side, with more than 90 percent of homeowners estimated to have no flood coverage; Those that do have flood coverage tend to get it through the National Flood Insurance Program (NFIP). The graphic below highlights that a majority of active NFIP policies are located immediately along coastlines and often in hurricane-prone areas. Some spots along major rivers do have somewhat higher take-up, but those values are often below 10 percent on a county-level basis.

Exhibit 14: National Flood Insurance Program (NFIP) Take-Up Percentage of Homes by County


The opportunity and need around flood, however, is greater than the current take-up may imply, likely fueling the investment in the area. Potential offerors of private flood solutions desire a solid understanding of risk before taking the plunge. The flood peril is also increasing in importance in Lloyds market as more Syndicates are writing private flood binders. The first generations of flood models resulted in widely different risk estimates, due to very different hazard generation methodologies and lack of detailed, location specific claims data on which to build the vulnerability components. Due to this (and despite the rapid evolution of models in this space), 50 percent of London insurers surveyed have identified North America flood as being the most important peril not being adequately captured in catastrophe models (from Aon’s 2019 View of Risk Survey). As the industry continues to pay more attention to flood and learn from recent events, inland flood models should continue to develop and similarly markets should start to gain some comfort in a chosen view of flood risk, and those that do not will be left in the dust.

Wildfire Wildfire is a ‘middle of the road’ peril compared to SCS and inland flood. Insurance penetration in the U.S. is greater than flood, but not quite as high as SCS. Similarly, the industry investment in analytics tools for this peril is higher than SCS but does not appear to be quite as high as inland flood. Given the huge wildfire losses over the last several years, wildfire is emerging as an increasingly key risk for some insurers. Until recently, wildfire was a ‘forgotten’ peril, often eclipsed by earthquake / fire following in the western states and myriad other perils elsewhere. But that view is changing for some insurers that have been hit hard recently. In fact, 59 percent of London insurers surveyed uses a probabilistic solution to model wildfire (from Aon’s 2019 View of Risk Survey).

In California, beyond the insurance take-up gap that exists, an additional concern since 2017 has been underinsurance. Studies in the aftermath of the 2017 and 2018 fire sieges found that 80 percent of damaged properties were underinsured. In many cases, policyholders faced more than USD100,000 in uninsured damage costs. To that end, there have been 14 individual billion-dollar insured wildfire events on record. Of those 14, nine have occurred since 2015. The United States accounts for 11 of the events, followed by two in Australia, and one in Canada.

Climate Change: An Industry Re-Evaluation of Weather Risk Perhaps no topic has become more engrained into the global social fabric, and consequently the re/insurance industry and its partners, in the past decade than climate change. With financial institutions joining re/insurers in becoming much more involved in the subject in recent years, this has resulted in several new initiatives to ensure the fiscal health of organizations should increasingly large disasters occur. This was led by the 2015 Task Force on Climate-Related Financial Disclosures (TCFD) initiative that sought to improve transparency around how climate change may affect company financial statements and investments. Other more localized initiatives on a country level were seen in Europe and Asia. One such example from 2019 was the Prudential Regulation Authority (PRA) by the Bank of England that required banks and insurers to implement stress tests by considering how future climate change scenarios could affect their balance sheets. Insurers are actively preparing for a new round of tests scheduled for 2021 (Biennial Stress Tests for UK Banks and Insurers).

Risk mitigation and resilience has only become that much more important to re/insurers in 2020 as organizations seek new ways to address and more accurately quantify the risk. The insured financial cost of weather-related events in the United States, for example, has notably grown in the past decade, and much of that growth has been from secondary perils. Aon has prioritized the development of new strategies and products around the increasing risks from climate change in collaboration with key partners.


Aon is investing in a partnership with a leading climatology institute, RiskLayer, to develop a global (re)insurance climate change scenario tool. The project, Global Climate Hazard Map, will deliver a series of maps for different emissions scenarios and time horizons to identify geographical areas at most risk to the combined impacts of climate change. The maps will be integrated into ImpactOnDemand, Aon’s exposure management and visualization platform, and will consider key variables such as heat stress, sea level rise, change in wildfire risk, and impacts of precipitation changes, among others. The maps are intended to be accessible and assist in conversations around risk management in a changing environment.

Aon has also recently announced a collaboration with The Climate Service (TCS). This provides a unique view of combining climate-related hazard data with econometric models to give clients an opportunity to identify their financial risk down to a specific asset level. As organizations seek to better quantify and frame the growing questions around transition and physical risk, TCS enables users to view various climate change scenarios across different perils and regions to conduct their own sensitivity and stress test analyses.


Forecasters: Extremely Active 2020 Atlantic Hurricane Season The three main hurricane season prognosticators (National Oceanic and Atmospheric Administration (NOAA), Colorado State University (CSU) and Tropical Storm Risk (TSR)) have all forecast an extremely active 2020 Atlantic Hurricane Season. As of early September, the season had already recorded 15 named storms and 5 hurricanes. The United States alone had cited seven landfalls through August: Bertha (South Carolina; Tropical Storm), Cristobal (Louisiana; Tropical Storm), Fay (New Jersey; Tropical Storm), Hanna (Texas; Category 1 Hurricane), Isaias (South Carolina; Category 1 Hurricane), Laura (Louisiana; Category 4 Hurricane), Marco (Louisiana; Tropical Storm). The seven landfalling storms set a new U.S. record for named storm landfalls through August based on data to 1851.

Each agency cites the likelihood of a weak La Niña occurring during the rest of the peak months of the 2020 season – September and October – while combining with well-above normal sea surface temperatures, below-normal sea level pressure, and below-normal trade winds across the Atlantic’s Main Development Region (MDR). These amplified metrics have created ideal atmospheric and oceanic conditions for accelerated cyclogenesis. The conditions are anticipated to persist through the rest of the season. Climatology indicates that roughly 67 percent (two-thirds) of Atlantic Hurricane activity occurs after August 20.

As always, it only takes one landfalling storm to entirely alter the perception of a season from a financial loss perspective – regardless of how meteorologically active or inactive a year may be.

Exhibit 15: August 2020 Atlantic Hurricane Season Forecasts

Named Storms Hurricanes Major Hurricanes TSR 2010-2019 Average 16 7 3 2020 24 10 4 CSU 1981-2010 Average 12 6 3 2020 24 12 5 NOAA 1981-2010 Average 12 6 3 2020 19-25 7-11 3-6

Sources: Tropical Storm Risk (TSR), Colorado State University (CSU), NOAA


Contact Information Tracy Hatlestad Executive Managing Director Reinsurance Solutions +1 952 886 8069 [email protected] Greg Heerde Head of Analytics & Inpoint, Americas Reinsurance Solutions +1 312 381 5364 [email protected] Kelly Superczynski Executive Managing Director Capital Advisory, Americas +312 381 5351 [email protected]

Dan Dick Executive Managing Director Head of Catastrophe Risk Management +817 296 2283 [email protected]

Peter Cheesman Head of Analytics, APAC Reinsurance Solutions +61 2 9650 0462 [email protected] Mike Van Slooten Head of Business Intelligence, International Reinsurance Solutions +44 0(20) 7522 8106 [email protected] Marie Teissier Business Intelligence, International Reinsurance Solutions +44 0(20) 7522 3951 [email protected]

© Aon Securities Inc. 2020 | All Rights Reserved Aon Securities Inc. is providing this document and all of its contents (collectively, the “Document”) for general informational and discussion purposes only, and this Document does not create any obligations on the part of Aon Securities Inc., Aon Securities Limited or their affiliated companies (collectively, “Aon”). This Document is intended only for the designated recipient to whom it was originally delivered and any other recipient to whose delivery Aon consents (each, a “Recipient”). This Document is not intended and should not be construed as advice, opinions or statements with respect to any specific facts, situations or circumstances, and Recipients should not take any actions or refrain from taking any actions, make any decisions (including any business or investment decisions), or place any reliance on this Document (including without limitation on any forward-looking statements). This Document is provided for the purpose of providing general information and is not intended, nor shall it be construed as (1) an offer to sell or a solicitation of an offer to buy reinsurance, (2) an offer, solicitation, confirmation or any other basis to engage or effect in any transaction or contract (in respect of reinsurance, a security, financial product or otherwise), or (3) a statement of fact, advice or opinion by Aon or its directors, officers, employees, and representatives (collectively, the “Representatives”). Any projections or forward-looking statements contained or referred to in this Document are subject to various assumptions, conditions, risks and uncertainties (which may be known or unknown and which are inherently unpredictable) and any change to such items may have a material impact on the information set forth in this Document. Actual results may differ substantially from those indicated or assumed in this Document. No representation, warranty or guarantee is made that any transaction can be effected at the values provided or assumed in this Document (or any values similar thereto) or that any transaction would result in the structures or outcomes provided or assumed in this Document (or any structures or outcomes similar thereto). Aon makes no representation or warranty, whether express or implied, that the products or services described in this Document are suitable or appropriate for any cedent, sponsor, issuer, investor, counterparty or participant, or in any location or jurisdiction. The information in this document is based on or compiled from sources that are believed to be reliable, but Aon has made no attempts to verify or investigate any such information or sources. Aon undertakes no obligation to review, update or revise this Document based on changes, new developments or otherwise, nor any obligation to correct any errors or inaccuracies in this Document. This Document is made available on an “as is” basis, and Aon makes no representation or warranty of any kind (whether express or implied), including without limitation in respect of the accuracy, completeness, timeliness, or sufficiency of the Document.

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