About 200 years ago, the reinsurance market was born when the first known contract between two German insurers was signed. 

Things really took off in the 20th century, driven by industrialisation, globalisation, war and natural disasters.  

Last year, general insurers operating in Australia spent $2.5 billion on reinsurance for natural disaster claims. Without it, actuaries calculate they would have to either dramatically reduce coverage or raise $70 billion to match current capital levels. 

“Consumers and the community must recognise that the cost of risk transfer, while sometimes high, is always less than the cost of bearing uninsured risk,” Aon Reinsurance Solutions chief actuary Kate Bible says. 

The funding cost of extra capital would be higher than the margins charged by reinsurers, as they are more diversified than investors in Australian insurers, she says in a new Actuaries Institute paper. 

After poor performance in the six-year period to 2022, dramatic repricing by reinsurers in 2023 has created “a more sustainable but more expensive market” as the cost of natural disasters climbs.  

“For Australian consumers, this means higher premiums but greater confidence that insurers will remain solvent and stable when disasters strike,” Ms Bible says. 

“The capital relief that reinsurance provides, along with the stability to insurer returns, represents the difference between an insurance market that can serve consumers affordably and one that may become inaccessible to many consumers.” 

Reinsurance remains an essential pillar for Australia’s insurance market stability and capital relief, she says, and the money spent on reinsurance last year reduced catastrophe exposure from $43.7 billion to $3.7 billion – a material capital benefit. 

“It is crucial to not focus on the quantum of the $2.5 billion as the ‘cost of reinsurance’. A large portion of that cost would exist with or without reinsurance, as it is the expected cost of natural perils events that forms part of the expected claims costs that an insurer will determine in pricing,” Ms Bible says. 

The insurance industry in Australia had an insurance concentration risk charge (ICRC) – the net financial impact of a large natural peril event after the application of any reinsurance – of $3.7 billion at March 31. It had a total capital requirement of $18.6 billion, and eligible capital of $33.9 billion. 

The prudential regulator expects insurers to operate above the minimum, and at the industry’s current coverage ratio of 1.82 times the requirement, it would need to raise $70 billion to keep capital coverage at the same level. 

“Without excess of loss reinsurance, we estimate the ICRC would increase by $40 billion and the insurance industry in Australia would absorb that $15.3 billion of excess capital,” Ms Bible says.  

“Should reinsurance be removed, insurers will instead need to raise the capital via debt or equity from their shareholders to continue to operate as an insurer. 

“Debtholders and shareholders would expect a return on their investment ... akin to the margin within the premium charged for the reinsurance ... That is, removal of reinsurance will not necessarily reduce consumer premiums.” 

Australia and New Zealand are home to some of the largest catastrophe reinsurance programs in the world, given their significant exposure to cyclones and earthquakes.  

The market for alternative capital such as catastrophe bonds has grown to $US115 billion ($175.73 billion), outstripping growth in traditional reinsurer capital. 

But Australian regulations limit credit to these potentially cheaper funding sources. Ms Bible says material adjustments to these regulations could improve pricing and terms for some components of reinsurance. 

In July, Suncorp replaced its traditional reinsurance cover with a solution in which reinsurer losses are capped at $600 million over a three-year term. It includes further expected upside from a profit-sharing mechanism. 

While the margin above the expected loss will be met by decreased profit for Suncorp and/or passed onto consumers, the profit-sharing “will dampen this impact”, Ms Bible says. 

The arrangement is likely to give material capital relief in the Australian Prudential Regulation Authority’s ICRC calculation, and shows how innovation brings global capital down under for a reduced ultimate cost to consumers.  

“This capital relief that reinsurance provides insurers, along with the stability of returns to their investors, represents the difference between an insurance market that can serve consumers affordably and one that may become inaccessible to many consumers,” Ms Bible says. 

See the report here.  

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