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APAC's Costly Catastrophes: Reinsurance And More Required

The Asia-Pacific region's insurance and reinsurance sector saw its fair share of weather-induced woes over the past two years. And now, the pandemic is adding to this list.

After seeing significant catastrophe losses, insurance and reinsurance price hikes seem inevitable. However, we believe the need for reinsurance protection has strengthened amid the successive catastrophes. This need has become more urgent with the unfolding of the COVID-19 pandemic. At the same time, numerous disasters across the Asia-Pacific, or APAC, region highlighted important considerations for the broader reinsurance industry. We believe global reinsurers will continue to view the region as one of growth and diversification, despite increasing catastrophe losses.

S&P Global Ratings believes the underlying proposition of reinsurers and insurers remains unchanged: They help policyholders manage risk and reduce financial burdens related to extreme weather and, more recently, pandemic-induced losses. Based on our recent study of rated Asia-Pacific reinsurers (China Reinsurance (Group) Corp., Korean Reinsurance Co., Toa Reinsurance Co., Taiping Reinsurance Co. Ltd., and Central Reinsurance Corp.), an average of 15% of their equity is exposed to extreme natural catastrophes (1-in-250 year return period level). This is lower than the average 27% exposure of the top 20 global reinsurers. In our view, this shows there is scope for deepening insurance uptake of reinsurance in APAC, even though this would come with risk. For the region's reinsurers, rapid urbanization and an evolving risk landscape make deepening an understanding of changing operating conditions an urgent matter. The need to manage catastrophes that are more frequent and severe than the historical average, an acute combination of catastrophe events, and mounting concerns around concentration risk and risk accumulations are central for reinsurers operating in the region.

Chart 1

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Sobering Moment

In 2019, insured catastrophe losses in Asia were significant, exceeding the global advance estimates. Dominated by the two most costly events, typhoons Faxai and Hagibis in Japan, 30% of insured losses globally came from Asia, according to Swiss Re sigma. Looking back at catastrophe modeling results with hindsight, these two typhoons were extreme and generated higher losses than anticipated for many reinsurers. We calculate that the top 20 global reinsurers cover roughly a third of Japanese incurred losses for 2019.

Chart 2

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Japan is no stranger to natural catastrophes. The country has a long history of having to adapt to life with natural disasters such as typhoons and earthquakes. Since World War II, the country has put significant effort into disaster mitigation and related data collection. In spite of being equipped with catastrophe models supported by detailed historical data and a strong knowledge of domestic risk landscapes, the significant loss creep arising from typhoon Jebi in 2018 and high frequency of successive typhoons in 2018 and 2019 took the domestic insurers and global reinsurance industry by surprise. By the end of 2019, insurance claims from Typhoon Jebi ballooned to more than US$12 billion (doubling from 2018's estimates). The successive typhoons of 2018 and 2019 broke five of the top 10 wind/flood insurance payment records.

Chart 3

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Typhoon Jebi's loss creep serves as a timely reminder around the evaluation of risk concentration in megalopolises and other large urban areas and of the need for catastrophe models to incorporate updated information on city landscapes and building codes. External research points to a combination of factors, such as higher wind speed, maintenance of buildings, and inflating claims due to lack of workers to do repairs as behind the loss creep. In the case of Typhoon Jebi, we see the increased concentration of risk in Japan's industrial belt as a factor. In particular, with increasing urbanization in Greater Tokyo (including Kanagawa, Chiba, and Saitama prefectures) and the Kansai area, (including Osaka and Kyoto and Hyogo prefectures), the danger of concentrated damage calls for underwriters to scrutinize risk accumulation more closely.

Chart 4-1

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Chart 4-2

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Chart 4-3

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Chart 4-4

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After Protection, Payback

In the two years following the typhoons, Japanese insurers substantially drew down catastrophe loss reserves. We expect recent losses related to COVID-19 will reduce insurers' profit in fiscal 2020, leading to further capital buffer deterioration. Based on the tendency for Japanese insurers to try and keep a lid on earnings volatility related to natural catastrophes, we believe the appetite for domestic catastrophe risk will be limited and demand for reinsurance will persist. In fact, the insurers have taken a number of steps to enhance reinsurance cover, built up reduced catastrophe loss reserves, and tightened their underwriting standards in high-risk regions and for corporations with potential high-risk concentration.

Chart 5

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In return for maintained or partially enhanced cover when possible, major Japanese non-life groups accepted large reinsurance rate hikes as well as renegotiations on portfolios to the benefit of reinsurers in terms of risk taken on (payback). Property catastrophe reinsurance pricing in Japan rose during April 2019 renewals, which brought about 15% to 25% rate increases in loss-hit layers, according to Willis Re. In 2020, prices for loss-hit layers continued rising, by 30% to 50%.

In parallel, insurers have been trying to raise fire insurance prices since 2019; some are also planning to reflect flood risk more closely in their pricing in conjunction with hazard vulnerability maps produced by local governments. However, we believe it would take many years to improve product profitability to healthy levels due to the long duration of policies in-force for retail contracts and Japanese pricing practices, which are based on a progressive review of the industry association's reference rate.

Protection Amid Catastrophes Means Price Hikes

While reinsurance programs are effective for mitigating losses, we believe underwriting discipline remains another core focus for our rated insurers and reinsurers. A strong understanding of the urban and geographic landscape, a defined risk appetite, and prudent balance sheet management are key to sustainable profits.

Like Japan, Australia insurers continue to see the benefits of large reinsurance programs after successive catastrophes. Australia's insurers are amongst the world's largest purchasers of reinsurance coverage, with Insurance Australia Group Ltd at the top of the list with cover provided across Australia and New Zealand. Since the beginning of the bushfire season in late calendar 2019, Australia's property/casualty (P/C) insurers claims management teams--and earnings--have been continually pressured by significant natural disasters, from bushfires to hail storms to strong winds to flooding. To the end of September 2020, catastrophe claims related to the four recent natural disasters passed A$5.2 billion (approx. US$3.7 billion). Claims related to the bushfire catastrophe (affecting the states of Queensland, New South Wales, Victoria, and South Australia) alone exceeded A$2.2 billion.

However, the ongoing availability of large reinsurance programs comes at a price. Particularly with the pricing cycle on an upward trajectory and tightening underwriting terms, we believe reliance on reinsurance alone cannot overcome weather-related challenges. The industry's ability to establish additional solutions to natural perils and the pandemic will be key. It could do this through measures such as implementing government backed schemes or seeking new capital resources from alternative investors.

Australia's declared catastrophes have been incrementally increasing in frequency over the past 50 years, with the average cumulative cost relatively steady over the past ten years at about A$2.3 billion per year to the end of calendar 2019 (Chart 6). A simple extrapolation of claims experienced from January 2020 to September 2020 for the following three years indicates a lower frequency of events but higher aggregate severity of claims.

On the back of global warming and climate change, the concerns about increasing catastrophe frequency will weigh heavy on the mind of direct insurers. To enhance preparation against these extreme events, wider use of multiyear contracts or longer contract periods may be sought by Australia insurance companies. Australian P/C insurers have signed on to reinsurance programs containing reinstatements, top-and-drop cover, and multiyear cover attributes. Without a doubt, reinsurance protection had proved useful for them. Since 2008, the benefits from reinsurance have strengthened, and in the year to June 30, 2020 provided 28% cover for claims incurred (Chart 7).

Chart 6

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Chart 7

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Time To Speed Up The Walk

The surge in extreme weather events suggests the broader effects of climate change could be raising disaster risk amid rapid urbanization across the region. In China, COVID-19 and recent severe floods have led to a renewed push by Chinese authorities to deepen the penetration of catastrophe insurance. This is also facilitated by a three-year action plan released by the CBIRC in early August 2020. China is exposed to flooding, earthquakes, and typhoons. Furthermore, its rapidly changing urban landscape makes historical data less representative of the actual risk exposures. In our view, uneven insurance penetration across the country and a lack of awareness of insurance among many limits the effective use of reinsurance to insulate against financial losses.

The 2020 China floods bring back memories of those that wrought devastation in 1998. We believe the severe floods will likely weigh on underwriting results in 2020 for some P/C and reinsurance market participants. Intense rain and severe floods have impacted large tracts of southern China since early June 2020, resulting in auto, property, construction, and agriculture-related claims. The floods triggered RMB219.9 billion ( approximately US$30 billion) economic losses (according to the Ministry of Emergency Management in China). The China Banking and Insurance Regulatory Commission (CBIRC) also released an estimate of approx. RMB2.4 billion insurance losses at the end of July. The wide gap between economic and insurance losses highlights in the lack of insurance penetration within affected regions.

Clearly, seeking protection against weather-induced economic losses will be key as the Chinese government works to reform the economy. In April 2020, the Shanghai Insurance Exchange launched typhoon and flood insurance for residential properties, supplementing the earthquake insurance released in 2016. Following President Xi Jinping's recent visit to Southern China, the acceleration to develop Greater Bay Area into an economic powerhouse will intensify this focus. With this region prone to winds and heavy rainfall, the momentum of insurance demand and awareness is likely to spike among the general public. Following Guangdong's experience of pilot catastrophe insurance program – first launched in 2016, we expect the local governments to enhance and establish more comprehensive catastrophe insurance frameworks.

Chart 8

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As the primary insurance market's accelerates its shift toward business segments other than autos, we believe the correlation between underwriting performance volatility and weather-related events will increase. In tandem with the shift in business mix, we expect the Chinese P/C insurers' oversight of catastrophe risks will intensify through enhanced reliance on catastrophe models. The country's largest reinsurer, China Reinsurance (Group), launched the first domestic proprietary commercial earthquake catastrophe model in August 2019. We expect insurers to proactively review their retained catastrophe exposures and risk mitigation arrangements. Technology will likely play an increasingly important role in areas such as data analytics and risk and claim assessments.

Chart 9

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Balancing The Trade-Offs

Reinsurance protection remains the go-to for the region's insurers as they seek insulation from natural catastrophes. S&P Global Ratings believes the value proposition of reinsurance will strengthen after recent tumultuous events: a series of natural catastrophes and the pandemic. However, hiking reinsurance price tags will leave insurers deep in thought as to how they can strike the balance between risk and return. While insurers could pass on the costs to policyholders, the economic considerations and potential social backlash may limit the price hike relay/transfer. Inevitably, higher reinsurance costs will narrow profit margins for the primary insurers.

Technological innovation related to pre and post-disaster management, and active utilization of catastrophe models, will facilitate reconsiderations of underwriting strategies for insurers and reinsurers. For the APAC insurance sector, the partnership with reinsurance companies are here to stay. We believe higher reinsurance premiums will also lead to calls for reinsurers to enhance their offerings and services to insurers, by providing more technical know-how and underwriting support.

This report does not constitute a rating action.

Primary Credit Analysts:Eunice Tan, Hong Kong (852) 2533-3553;
eunice.tan@spglobal.com
Koshiro Emura, Tokyo (81) 3-4550-8307;
koshiro.emura@spglobal.com
Secondary Contacts:Craig A Bennett, Melbourne (61) 3-9631-2197;
craig.bennett@spglobal.com
WenWen Chen, Hong Kong (852) 2533-3559;
wenwen.chen@spglobal.com
Charles-Marie Delpuech, London (44) 20-7176-7967;
charles-marie.delpuech@spglobal.com

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