According to Hiscox Re & ILS, successful navigation of the reinsurance cycle requires proactive portfolio management, where strategic capital allocation plays a central role alongside diversification, retention strategy, and asset allocation, traits that are all the more important at phases in the market cycle such as we see today.In its latest whitepaper, the firm stresses that anticipating the impact of macro and micro drivers allows managers to position portfolios effectively as market conditions evolve.The firm specifically noted that strategic asset allocation, diversification across perils and geographies, and the careful calibration of retention levels are all essential tools in the portfolio manager’s arsenal.Hiscox Re & ILS also includes the Hiscox ILS division, which manages insurance-linked securities investment strategies for third-party investors.

“At its core, the reinsurance pricing cycle refers to the recurring pattern of rising and falling prices for reinsurance coverage, typically oscillating between ‘soft’ and ‘hard’ markets.In a soft market, capacity (reinsurance capital) is abundant, competition among reinsurers is fierce, and pricing tends to decline, often resulting in broader coverage terms and more relaxed underwriting standards.This environment may entice insurers to purchase more reinsurance protection but can also lead to under-pricing of risk and thinner margins for reinsurers,” the paper reads.

Moreover, while the market is starting to show signs of some softening, signals are currently indicating that retentions are remaining generally elevated, and in some wildfire-affected cases, retentions are said to be increasing.“Hiscox Re’s portfolio of natural catastrophe risk, available in our sidecar, has delivered a long-term return of 10.0% annualised compared to an expected mean annualised return of 9.3% over three decades.This illustrates our effective management of both the reinsurance cycle and catastrophic events,” the paper reads.

The firm’s whitepaper also outlines how capital allocation is one lever that’s available for managers to consider and use when adapting portfolio construction to shifts in the market cycle.When the market softens, portfolio managers can also respond by reducing overall capital allocated, which helps to limit downside risk and also preserves capacity for redeployment when conditions improve.Another key lever available to mitigate portfolio downside during softening markets is increased portfolio diversification.

“A portfolio that is well-diversified by geography, peril and counterparties will generally derive portfolio resilience from a lack of reliance on a single point of exposure.There is also a benefit in cycle management to being exposed to multiple pricing cycles in differing geographies and products – resulting in a dampening effect to the impact on a portfolio due to the combination of pricing cycles.For example, the drivers of market pricing in retrocession (the transfer of risk from one reinsurance company to another reinsurer) and cyber reinsurance are different and only partially correlated,” the paper reads.

Adding: “A diversified reinsurance portfolio will also typically be anchored by a core allocation to lines of business characterised by lower price volatility and more predictable results such as United States (US) Nationwide insurers.These core holdings provide stability, allowing the portfolio to weather adverse market cycles without excessive swings in performance.” Amongst this stable core, Hiscox Re & ILS stated that a satellite strategy is employed, which selectively pursues opportunities by geography or product as and when market conditions become attractive.The firm went on to explain that within a hard market, satellite allocations may expand to capture outsized returns; conversely, in soft phases, these exposures are pared back, maintaining discipline and capital efficiency.

“Our approach to core and satellite strategies is centred around long-standing relationships with cedants.Built on transparency around portfolio appetite, these connections enable us to anchor portfolios with stable core allocations, while dynamically adjusting satellite exposures as market opportunities arise.Supported by advanced analytics and modelling, we can confidently optimise allocations, ensuring portfolio resilience,” Hiscox Re & ILS explained.

“The use of hedging also ebbs and flows across the market cycle, typically becoming more attractive as a soft market deepens and the cost of structuring protection declines.During these softer phases, portfolio managers may increase their utilisation of hedging instruments – such as catastrophe bonds, industry loss warranties, or quota share arrangements – not only because the cost of these tools drops, but also due to the enhanced structuring flexibility available.” The firm goes on to note that this provides an efficient means to manage downside risk, stabilise earnings and enhance capital usage.Concurrently, as hedging becomes more affordable, it shifts from being a secondary consideration to a strategic lever, which allows managers to fine-tune exposures and maintain capital efficiency even as risk-adjusted returns compress.

Furthermore, Hiscox Re & ILS noted that the approach to navigating the market cycle is shaped by the primary objective of the portfolio manager, and capital allocation forms the fulcrum upon which strategic decisions are balanced.In broader terms, three distinct philosophies can be identified, each with its own risk-return profile and tolerance for volatility: the constant exposure approach, the hard market approach and the cycle-managed strategy.“The constant exposure strategy prioritises stability above all.

By maintaining a steady, unwavering level of capital allocation throughout the cycle, it minimises the portfolio’s volatility by avoiding over-allocation, shielding the portfolio against the most dramatic fluctuations in returns.This approach is particularly favoured by those for whom predictability is preferred, such as stakeholders with strict solvency requirements or less appetite for downside risk.This conservatism does sacrifice the possibility of outsized gains when market conditions become favourable again, opting instead for a reliable – if muted – performance,” the paper reads.

Adding: “At the opposite end of the spectrum lies the hard market approach, which embraces the dynamic nature of the cycle.Here, portfolio managers swing capital allocations aggressively in and out of the market, seeking to maximise upside potential during periods of pronounced price hardening.This strategy can deliver impressive returns when market pricing is elevated, and structuring regimes are in the favour of capacity providers.

This approach does demand a robust tolerance for risk, as over-allocation to volatile conditions can result in sharp drawdowns should event losses spike.The hard market specialist must be able to both seize fleeting opportunities, and ride-out losses from large events.Heightened event activity during periods of market hardening will typically prolong periods of favourable market conditions.” The firm clarifies that situated between these two extremes is the cycle-managed strategy, which is a sophisticated and adaptable method that adjusts capital allocation, hedging strategies, and portfolio focus areas in reaction to the fluctuations of market conditions.

Managers that employ this approach ultimately seek a balance: seizing the upsides of hard markets by increasing allocation, while reducing exposure and adopting a more refined approach to hedging strategies during softer phases to safeguard capital and control volatility.“This method requires careful analysis and timing, leveraging market intelligence and predictive signals to achieve target returns without unduly exposing the portfolio to event risk. Over the medium term, such disciplined management allows the core signal of the pricing cycle to override the unpredictable noise of catastrophic volatility, delivering a measured blend of growth and resilience,” Hiscox Re & ILS added.To conclude, the firm said, “A nuanced understanding of the reinsurance cycle requires not only vigilance, but also the ability to anticipate the implications of macro and micro drivers across a portfolio’s composition. Strategic asset allocation, diversification across perils and geographies, and the careful calibration of retention levels are all essential tools in the portfolio manager’s arsenal.

An agile approach enables insurers and reinsurers to respond rapidly as the market pivots between soft and hard conditions, adjusting treaty structures, layering, and ceded limits to optimise outcomes.The capacity to recognise early signals – such as tightening capital markets, shifts in regulatory requirements, or emerging risks from climate change and technological disruption – can provide a competitive edge, allowing managers to seize opportunities or buffer portfolios from adverse developments.”.All of our Artemis Live insurance-linked securities (ILS), catastrophe bonds and reinsurance can be accessed online.

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