New capital and ‘competitive convergence’ credit negative for reinsurers: Moody’s

It’s ratings agency report season as all three of the main agencies have published reports on the reinsurance sector in advance of the Monte Carlo Rendezvous next week. So please excuse the increased frequency of articles, but we feel it’s worth highlighting any relevant points. The latest report comes from Moody’s who say they are maintaining a stable outlook on the global reinsurance industry, but note that new capital coming into the convergence part of the market is credit negative for reinsurers.

“Reinsurers have already emerged from the second worst year for insured disaster losses with more capital than they had at the start of 2011,” said Kevin Lee, senior credit officer at Moody’s. However, Moody’s notes that a large disaster, faltering primary rates or worsening of the global economy could place downward pressure on the reinsurance industry’s stability.

Moody’s make some interesting comments on the convergence of the capital markets with reinsurance via investor capital flowing into the sector in search of uncorrelated returns and diversification. Moody’s says that ‘competitive convergence’ is a key challenge for the reinsurance industry, and is making it more difficult for reinsurers to create distinct strategies. An interesting point and something we’ve noted before, such as here where we discuss the catastrophe bond market becoming competition for traditional reinsurance or here where Fitch said alternatives to reinsurance are becoming sustainable, which leads us to believe that innovation is key for reinsurers to enable them to differentiate themselves and attract capital.

New capital is being steered into catastrophe risk and alternatives, with dwindling prospects in life reinsurance and casualty one of the drivers. Moody’s says the ongoing shift from direct to broker business is making it easier for new entrants to compete as well. Both cyclical and secular factors are driving new capital into reinsurance and catastrophe risk according to Moody’s, with around $6 billion having entered the sector since 2011 raising the amount of alternative form capital in reinsurance to $34 billion.

Overall, Moody’s says that they find this new capital to be credit negative for the incumbent reinsurers, particularly now when the industry has ample capital (as we noted in this article yesterday), the additional capital flowing into non-traditional reinsurance alternatives can drive down revenues and margins and suppress rates.

On the upside, Moody’s says that the fact that capital flows into the reinsurance sector, even if it is into alternatives such as catastrophe bonds, sidecars and collateralized vehicles, shows that investors are still interested in reinsurance even though they may not be interested in reinsurance equity investments. We commented on exactly that in this article published earlier today discussing a Standard & Poor’s report on the sector capital inflows. Moody’s closes by saying that; “In a stress scenario, new capital, no matter what form it takes, can be a saving grace for wounded reinsurers. Reinsurers who find it hard to recapitalise in equity markets may still be able to find partners for sidecars, which will allow them to keep writing business and maintain a franchise. ”

So it seems that the viewpoint on convergence capital as growing competition for traditional reinsurers is itself converging to become the norm among industry observers. This has been our view for some time, but we do feel that as well as providing what we feel is beneficial competition it also offers reinsurers a chance to show that they can become more innovative and find new models to attract capital back to their traditional operations. As we’ve said before, it’s going to be interesting to see where the capital flows to in 2013 and the January renewals will be telling.

Here’s a few of our other recent articles on this topic:

– Investors more interested in catastrophe bonds and sidecars than new reinsurers: S&P

– Global reinsurer capital up 5% to $480 billion: Aon Benfield

– Reinsurance industry able to withstand larger loss thanks to capitalisation: Fitch

– Capital market alternatives to reinsurance are increasingly viable and sustainable: Fitch

– Collateralized reinsurance capacity is disrupting the traditional market

Subscribers to Moody’s can access their full report here.