Reinsurance capital to increase again after limited Q1 catastrophe losses

Global reinsurance industry capital levels are set to increase once again as reinsurers are forecast to report solid underwriting profitability for the first quarter of 2014 due to a limited amount of catastrophe losses, according to Fitch Ratings.

Fitch forecasts that reinsurers’ results for the quarter will be in line with those reported in 2013, as the reinsurance industry has not suffered any significant catastrophe loss events since Hurricane Sandy struck the U.S. northeast in the fourth quarter of 2012.

Fitch explained in an update:

The largest insured natural catastrophe losses for the period were from severe winter storms in the US and flooding and winter storms in the UK. We believe that losses from these events will be manageable for the (re)insurance industry, especially as the most exposed firms are typically large, well-diversified operators with the ability to offset losses through other profitable lines and strong capital.

Reinsurers will only have to shoulder a minority of the losses, as these events were not costly enough to trigger insurers’ excess of loss property catastrophe reinsurance treaties. Losses for reinsurers will generally be limited to facultative, per risk and pro rata quota share reinsurance treaties. In the case of the US, this was partly due to increased retentions by primary insurance companies over the last few years, as improved capital positions have allowed insurers to retain more risk.

While this will be good news for many reinsurance company CEO’s, with another strong quarter of earnings set to please their investors, the issue once again will be what to do with the growing store of capital. Reinsurers have been struggling to put excess capital to work, in a market awash with capital both from traditional reinsurers as well as from non-traditional sources such as capital market investors like pension funds, hedge funds and money managers.

At a time when competition in the reinsurance market is reaching new highs due to high levels of capital and interest from institutional investors, which is forcing rates down and softening many lines of business and perhaps tempering the reinsurance cycle itself, reinsurance CEO’s may welcome some larger catastrophe losses.

With some core lines of business now becoming less attractive to traditional reinsurers due to declining pricing, some are looking elsewhere for opportunities to deploy capital into other lines of reinsurance or even primary insurance business. But if capital continues to grow and opportunities are restricted to moving into other, already established lines or regions, those areas too are going to become less attractive to switch focus to.

As Artemis reported earlier this week, the decline in reinsurance pricing has continued at the latest renewals on April 1st, with reinsurance broker Willis Re reporting rates down as much as another 20% and expecting that trend to continue at the June/July mid-year renewals.

The result of that will be more returning of capital. Share buybacks, special dividends, perhaps acquisitions, will all look more appealing that deploying capacity into areas of the market where a reinsurers confidence to underwrite may not be so high. So experiencing solid quarter after solid quarter of results may actually be the last thing a reinsurer really wants at this time.

With share buybacks and capital returns there is also an element of reinsurers not being able to find use for their capacity at reasonable returns, while being aware that if they deploy capital they too could add further pressure on rates, further reducing their own profit per unit of risk.

The other issue to note is that while good quarters are building more capital, which often has to be returned, they are also exacerbating the pressure on reinsurance pricing and terms. This means that reinsurers may be getting more exposed, for lower-profit per unit of risk.

This is fine if your cost of capital is low, like some ILS funds, collateralized players and well organised traditional reinsurers, but for some reinsurers there is an increasing risk that when the bad quarters return, which they inevitably will, they could find themselves facing larger than expected losses.

Artemis expects that even after returning significant amounts of capital in recent months, the measures of global reinsurance capital provided by brokers such as Aon Benfield and Guy Carpenter are likely to show further increases. With alternative reinsurance capital also growing, and significant sums of capital still sitting on the reinsurance sidelines, the pressure on pricing is going to be a factor that reinsurers have to contend with for some time to come.

Some other related reading:

– Capital market threat could be reinsurance game-changer: A.M. Best.

– Munich Re: Reinsurance market competitive as capital spills over.

– Traditional reinsurers challenged to compete on cost-of-capital.

– For reinsurers growth via alternative capital may be most attractive.

– Share repurchases, start of a change in reinsurer capital structure?

– Capital, convergence, competition = reinsurance renewal rates fall.