The world is more dangerous. Why is risk cheaper?
Capital is pouring into insurance because of high returns and low volatility. But some professionals are worried about mispricing
Insurance executives are used to dealing with a crisis. Paid to evaluate the world’s risks, they are familiar with hurricanes, earthquakes and terrorist attacks.
But the danger facing Laurent Rousseau of Marsh, the world’s biggest insurance broker, as he sits in offices overlooking the Tower of London, is his sector’s falling prices.
A riskier world should be a boon for his industry: companies and governments are seeking to offload their growing exposure to perils ranging from natural disasters and war to trade conflict and street riots. Disaster protection has rarely been more coveted.
For the past few years, the industry has enjoyed bumper profits. But Rousseau and others like him fear that insurers — backed by a flood of financial capital — may now be underpricing the risk they are taking on.
At the same time as risks are multiplying, coverage is becoming cheaper to buy. Cyber insurance prices, for example, have fallen by about 40 per cent since a peak in 2022, broker data shows, despite a rise in digital attacks.
Sometimes, Rousseau says, there is “a huge gap between the financial performance of the industry and the underlying risk pricing. At the moment, that gap is widening.”
The disconnect between risks and prices is a striking example of how waves of big money have distorted even the most established of industries. It is a phenomenon that in the case of insurance has pushed down premiums — a trend people in the industry worry cannot be sustained.
Brokers say that cover is being offered at rates that are profitable for insurers today “in accounting terms”, but which could drain value over the longer term once claims add up.
Sensing a toppy market, Rousseau and 20 members of his team spent two days in June drawing up “a playbook for the next insurance crisis”, war-gaming the scenarios that could cause the sector its next big loss — and spark the next big shake-out.
On the list were cyber outages, natural disasters and even a meltdown in insurers’ investment portfolios, with some institutions increasingly exposed to the troubled US private credit sector.
The exercise reflects mounting concern from senior insurance figures, who warn that strong performance is now attracting more capital than insurers know what to do with. When the crunch comes, they fear, players that took on too much risk too cheaply during the boom years will go bust.
The profit-disaster cycle
Historically, the industry goes through cycles.
Traditionally, if the sector racks up strong profits new entrants come into the industry, pushing down the price of risk, policyholder premiums and eventually profits themselves. After a run of disasters occurs, the accompanying surge in claims drains insurers’ reserves of capital and pushes some out of business.
As competitive pressures ease, insurers are then able to raise premiums, eventually fattening their bottom lines. Improving returns attract a fresh wave of capital, which brings prices back down until the next wave of disasters arrives.
But the current price slide is steeper than in the past, fuelled by capital from fast-growing alternative asset managers, hedge funds and sovereign wealth funds pouring into the sector, ready to take on rising real-world risks such as climate change and war.
“It is completely illogical that prices are dropping at the moment,” says The Fidelis Partnership chief executive Richard Brindle, one of the best-known figures in the commercial insurance market.
The prospect of high returns tied to random events rather than expected swings in monetary policy or corporate performance has made the sector hard to resist.
The glut of investment capital outstrips the insurable value of assets — buildings, ships, or intangibles like business revenue — on which insurers can collect premiums at current prices. Underwriters of all stripes are now trying to grow wherever they can.
Insurance for some lines, including the vast US property market, is being underpriced, Brindle warns: “If you’re not careful, you create a bubble.”
Lloyd’s of London: one of the big winners
A case study in the new money flooding insurance can be found behind the famous inside-out walls of Lloyd’s of London, the centuries-old marketplace which in many ways is a microcosm of global property, casualty and speciality insurance.
Accounting for around $71bn of the global $1.5tn market, Lloyd’s has been one of the biggest winners of the sector’s recent bull run. Its syndicates have taken home about £10bn in aggregate profits for each of the past three years — partly as a result of underwriters around the world hiking prices during the last cyclical upswing in 2023.
Once, these returns would have been shared among the tens of thousands of so-called Names, private investors who had long supplied Lloyd’s underwriting capital and assumed unlimited liability for losses. But many Names were wiped out by a run of catastrophic losses in the late 1980s and early 1990s, and institutional insurers stepped in to provide the extra capital the market needed.
Now, those institutional insurers are themselves being edged out by alternative investors. A decade ago, alternative sources of capital such as private market funds and insurance-linked securities accounted for just 3 per cent of members’ funds at Lloyd’s. They have since grown to more than 12 per cent.
It is not hard to see the appeal. Over the past 20 years, the return on capital from allocations to insurance syndicates in Lloyd’s of London has outperformed any broad allocation to global stocks and bonds on both a total and a risk-adjusted basis.
Under Patrick Tiernan, who became chief executive last year, the marketplace has improved its management of risk-taking, curbing over-reach by inferior underwriters while encouraging growth by better ones.
To mitigate the risk that return-chasing capital undercuts underwriting standards, syndicates seeking to operate must submit and refine business plans, capital models and assumptions each year.
They project the scope and scale of losses suffered under a set of predefined “realistic disaster scenarios” set by Lloyd’s, as well as the catastrophic scenarios each syndicate specialises in.
The marketplace still offers attractive returns, particularly for investors who can persuade their banks to issue them a letter of credit. This can juice returns by piling leverage on the leverage already involved in the business of insurance.
To attract the likes of New York-based asset manager Blackstone, Lloyd’s has emphasised its unusually efficient capital structure, as well as the diversification offered by investing in insurance.
Lloyd’s says that this means an insurer writing policies within its market needs around a third less capital compared with outside.
How big does a disaster have to be to push up prices?
Price pressures still weigh on Lloyd’s syndicates and their investors.
The most recent significant losses to the sector followed the 2017 north Atlantic hurricane season. As the cycle turned, pandemic-related supply-chain shocks and a drumbeat of losses from smaller storms helped push up premiums again.
But after prices began to sink in late 2024, even the devastating California wildfires were not expensive enough to prop up insurance rates. Broker data shows that prices have now been falling for seven straight quarters.
Brindle, of Fidelis, warns that “losses from climate have been low more by luck than by judgment over the past few years”.
“We’ve seen this movie before — people start cutting rates, and suddenly you have a stampede,” he adds. “That’s not the case yet, but certainly in the US property business, it’s getting pretty bad.”
Some insurers now find themselves privately longing for a big disaster to stimulate prices. Inga Beale, a previous Lloyd’s chief executive, caused a firestorm in 2017 when she confessed that hurricanes “in a perverse way . . . benefit the sector”.
A handful of disasters in regions with high asset prices — coastal Florida, earthquake-prone California and Japan — can end up distorting the broader market.
“You could get a political risk insurance buyer in eastern Europe, for instance, asking, ‘Why are we paying more because there just was a Florida hurricane?’” says David Flandro of broker Howden.
Today, underwriters are also trying to understand whether cyber criminals or rogue AI could trigger globally significant losses.
Insurers are already modelling scenarios in which AI agents unleash chaos — such as deepfake fraud, market manipulation or bodily injuries — that could leave companies exposed to big losses, potentially recoverable through their casualty policies.
Aon broker Kevin Kalinich has warned that such losses could potentially become systemic.
“The insurance industry can afford to pay a $400mn or $500mn loss to one company that has deployed AI that gave the wrong pricing on airlines, or gave the wrong healthcare diagnosis,” Kalinich says. “What they can’t afford to pay is if an AI provider makes a mistake that ends up in 1,000 or 10,000 losses — a systemic, correlated, aggregated risk.”
This time, is it different?
The question for the industry is what these new investors will do in the wake of a significant catastrophe. If they flee in fright, then the traditional cycle could renew — pushing prices up again.
For example, alternative investors were spooked when Hurricane Ian caused $67bn of insured damage in Florida at a time of rising inflation and interest rates in 2022. Large sovereign investors together yanked at least $4bn in capital during this period, according to people familiar with those decisions, amplifying the price rises.
When terms were finally agreed at the end of December that year, prices for reinsurance — insurance for insurers — jumped by as much as 200 per cent. The world’s largest reinsurer, Munich Re, has pointed to that price rise as a signal that alternative investors in the sector could pull out when the next crisis hits, sending rates soaring.
Critics retort that this is hypocrisy. Traditional reinsurers including Munich Re also raise their prices and pull back from some perils after large losses, with price effects that are ultimately passed on to consumers.
Another theory is that the new investors could permanently lower insurance prices. Asset managers seeking returns that are uncorrelated with broader equity and debt markets have shown persistent demand for investments such as catastrophe bonds, which pay out if a narrow set of criteria is met, even as spreads have narrowed.
Proponents of this view maintain that hedge funds, sovereign wealth investors and pension funds have wised up to the insurance price cycle — and will now chip away at it by buying the dip after big disasters.
“This idea that alternative capital is hot money that’s going to cut and run when there’s trouble — I don’t think that’s the case,” says Flandro. “If we can bring in more liquidity, maybe we can damp these price cycles.”
The next big catastrophe, whether a hurricane, pandemic or as yet unknown peril, will test whether the sheer scale of alternative capital entering the market has killed the industry’s traditional boom-and-bust cycle and pushed down rates for good.
Sceptics argue that the cycle will reassert itself, winnowing out weaker players and raising premiums again. “In the end,” Rousseau of Marsh says, insurers always “get caught up by the true price of risk”.
