The year 2023 was tough for insurers. Many had to use up their financial safety nets, leading to a strong focus on managing their capital and exploring different funding sources. This situation is described in a recent report by Aon, a major global professional services firm.

 Insurance Market Outlook

Positive Trends:  
Despite the challenges, there are some bright spots. Insurance prices are high in many areas, and there's a big demand for insurance. This makes the future look promising for the industry.

Ongoing Challenges:  
However, insurers are still dealing with several issues. They need to find ways to manage their capital more effectively and seek additional sources of funds to cover their needs.

 Aon's Capital Poll Findings

Reinsurance as a Major Capital Source:  
Aon's survey found that 60% of insurers used reinsurance as their main source of capital. Reinsurance is when an insurance company buys insurance from another company to protect itself from significant losses. Another 41% relied on equity, which means raising money by selling shares of the company.

Increased Retentions:  
Due to higher retentions in 2023, insurers had to hold onto more risk. This means they didn't transfer as much risk to reinsurance companies, which put pressure on their financial reserves.

Alternative Reinsurance Capital:  
In 2023, the amount of alternative reinsurance capital exceeded $100 billion. This type of capital comes from third-party investors, not traditional reinsurance companies, providing insurers with extra financial support.

 Future Capital Sources

Expected Trends:  
Looking ahead, 56% of insurers plan to use reinsurance, and 32% will look to equity for capital. They're also considering third-party capital but are less interested in legacy solutions. Legacy solutions involve selling old policies to other companies to free up capital, but with changing reserve requirements and social inflation concerns, this might change.

Capital Buffers:  
Although insurers still have enough capital overall, the challenges of 2023 reduced their financial safety nets. Aon's survey examined insurers' risk tolerance, their need for more capital, and their thoughts on current and future capital sources.

 Stakeholder Pressure and Capital Management

Stakeholder Demands:  
Many insurers feel pressure from stakeholders, like rating agencies, to increase their capital. Rating agencies assess the financial strength of insurance companies, and higher capital levels can lead to better ratings.

Higher Retentions and Earnings Volatility:  
Most insurers are now dealing with higher retentions, leading to more volatile earnings. This means their profits can fluctuate more due to holding onto more risk.

 Increased Focus on Capital Management

Exploring New Capital Sources:  
Insurers are exploring various capital sources as their capital needs change and new growth opportunities arise. They are looking for ways to manage their capital more effectively.

 Impact of Natural Catastrophes

Rising Retentions:  
After the difficult reinsurance renewals in January 2023, many insurers had to increase their retention levels. Nearly 70% of Aon's survey respondents said their retentions went up for policies renewing in 2023.

Natural Catastrophe Losses:  
Higher retentions led to more volatility in insurers' financial results, especially with natural catastrophe losses above historical averages. In 2023, severe convective storms (SCS) caused global economic losses of $94 billion, significantly impacting insurers.

 Differences Between Commercial and Personal Lines

Diverging Results:  
The survey showed differences between commercial and personal insurance lines. About 40% of respondents faced pressure to increase capital from various stakeholders. While the overall industry remained well-capitalized, regional insurers experienced more significant capital metric deterioration due to investment volatility and high insured losses from natural catastrophes.

 Rating Agencies and Capital Buffers

Erosion of Capital Buffers:  
Aon noted that many insurers' capital buffers, as measured by AM Best's Capital Adequacy Ratio (BCAR), had eroded significantly. Between August 2023 and March 2024, AM Best updated 316 rating units, with over 75% experiencing a decline in their BCAR.

Negative Rating Actions:  
Changes to AM Best's balance sheet strength assessment, linked to BCAR declines, were significant triggers for negative rating actions in 2023. Aon expects that rating agencies will focus on insurers' access to diverse capital sources in 2024.

 Strengthening Financial Ratings

Improving Financial Strength:  
Insurers aim to strengthen their balance sheets to improve their financial strength ratings. Aon's survey asked if additional capital would help meet growth targets. Sixty percent of respondents said their companies would benefit significantly from more capital to support growth opportunities.

 Future Outlook

Profitability and Growth:  
Although many insurers' profitability was below their cost of capital in 2023, they remain focused on disciplined underwriting. This means carefully selecting and pricing insurance policies to manage risks effectively. Insurers are also seeking opportunities to benefit from ongoing rate increases.

Summary:

The insurance industry faced significant challenges in 2023, leading to a strong focus on capital management. Insurers are exploring various capital sources to meet their needs and support growth. Despite the difficulties, the future looks promising with high demand and robust pricing in many insurance markets. Insurers must navigate these challenges while maintaining adequate capital levels and seeking new opportunities for growth.

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