The Australian Prudential Regulation Authority (APRA) has proposed changes to reinsurance-related capital requirements that Fitch Ratings suggests could strengthen the credit profiles of Australian general insurers over the medium term.
These changes are expected to improve access to reinsurance protection. However, Fitch said that the long-term impact on insurers’ capital and earnings will depend on factors such as catastrophe reinsurance pricing and the frequency and cost of natural disasters.
APRA’s consultation on the reforms includes requiring general insurers to purchase all-perils reinsurance coverage, reducing reinstatement requirements, and removing the need to hold reinstatement premiums as part of the insurance concentration risk charge (ICRC). These measures, if implemented, would not take effect until June 2026.
The proposed changes could encourage insurers to explore alternative reinsurance arrangements, such as catastrophe bonds and other insurance-linked securities. APRA previously highlighted these alternatives in August 2023, though their adoption in Australia has been limited compared to the global market.
Current reinstatement requirements for catastrophe reinsurance may have deterred their use. The proposed reduction in reinstatement requirements could provide more flexibility for insurers to consider these options.
Fitch Ratings noted that rising catastrophe reinsurance costs have led some insurers to increase their retention limits, exposing their capital and earnings to higher risks. For instance, Suncorp Group Limited raised its net retention under its main catastrophe reinsurance program for the financial year ending June 2024 from AU$250 million to AU$350 million.
The company also chose not to renew its aggregate excess of loss reinsurance, which typically covers accumulated smaller events.
The rise in reinsurance costs has been attributed to the increasing frequency and severity of extreme weather events. While the proposed reduction in reinstatement requirements may lower some costs, the requirement to purchase all-perils reinsurance coverage could lead to higher overall expenses.
Fitch noted that regulatory changes alone may not be sufficient to reduce costs if reinsurers continue to face escalating catastrophe losses. Capacity constraints could also limit availability, as global reinsurers showed reduced interest in all-perils coverage during the 2023 renewals.
Reinsurance purchasing decisions are influenced by internal risk appetites and rating agency capital considerations. In such cases, APRA’s proposed reforms may have limited impact on retention rates.
Currently, APRA requires insurers to hold capital sufficient to cover a one-in-200-year loss on a whole portfolio basis, with capital credit given for reinsurance up to this threshold. In comparison, New Zealand’s regulatory framework requires capital to cover a one-in-1,000-year earthquake event.
Expanding reinsurance options could enable insurers to manage net exposures without significantly increasing net retentions or probable maximum loss (PML) values, which Fitch views as a positive for credit profiles.
Fitch’s Prism Global model score, which assesses insurer capitalization, incorporates catastrophe risk through net PML. Measures that prevent large increases in net PML are expected to support insurers’ current credit ratings.
Fitch also highlighted the potential for negative impacts on capital and earnings if insurers face successive severe catastrophes without adequate reinstatements. However, the firm considers this risk to be low, as such events are expected to be rare. Nonetheless, the growing frequency and severity of natural disasters introduce uncertainty into these assumptions.
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