Expanding terms, competing with selves: A.M. Best on London re/insurers

In a report on London insurance and reinsurance market conditions, A.M. Best warns that expansion of terms and conditions will adversely affect results, while firms managing third-party capital are effectively competing with their own products.

The rating agency reports are coming thick and fast in the run up to Monte Carlo and the beginnings of discussions in preparation for the January 2015 reinsurance renewals. Pressure on reinsurers is mounting and no market is immune, as the over-capitalised traditional reinsurance market comes to terms with a growing alternative reinsurance capital pot which is competing with them for renewal business in perhaps the most competitive traditional market conditions in years.

As a result prices are declining, renewal contract terms and conditions are expanding and being relaxed and reinsurers all over the world are looking to diversification, new business lines, new markets and the management of third-party investors capital, as they try to navigate the challenging market environment.

A.M. Best’s report looks at London market insurers and reinsurers in particular and states that successfully navigating the difficult trading environment is the biggest challenge that London market insurers and reinsurers face.

There has been no change over the course of 2014. Reinsurance pricing continues to soften, competition remains high, alternative capital remains available in the form of catastrophe bonds, collateralized reinsurance, sidecars and institutional investors continue to show appetite to expand into the reinsurance linked asset class. At the same time this capital is unlikely to retreat following major catastrophes, says A.M. Best, as it enters the space with a long-term view.

One way that London market insurers and reinsurers are trying to protect their market share is by the relaxation and expansion of terms and conditions to compete with third-party capital, including multi-year renewals, reinstatements and offering wider coverage.

A.M. Best warns that it is concerned that the relaxation of terms and conditions will adversely impact London re/insurance market results over the next few years and says that it is “Closely monitoring how individual companies manage any subsequent increase in exposure.”

London insurers and reinsurers are also increasingly looking to manage third-party capital, to help them increase line sizes while leveraging their expertise. London market participants such as Beazley, Catlin and Hiscox are all managing third-party capital in special purpose syndicates, which A.M. Best describes as sidecar like arrangements, to give third-party capital access to their London market business written at Lloyd’s. Participants are also establishing ILS funds as another way to manage third-party capital and give it access to a share of their underwriting book.

A.M. Best warns that while these third-party capital management efforts can allow the re/insurers to offer larger lines to clients while earning management fees, they also risk cannibalising the firms core business. While managing third-party capital is one response to threat it poses, A.M. Best says that these firms are effectively managing instruments which compete with their own products and capacity.

Here the numbers matter, whether the business brought in and placed using third-party capital is incremental in some way and so adding profit to the bottom-line, or whether it is simply shifting business to another balance-sheet where fee income will likely not be as profitable as writing the same business using your own capacity.

Time will tell on both of these issues, of relaxed and expanded terms and the profits of underwriting on third-party capital versus a reinsurers own.

A.M. Best says that it expects the trend of third-party capital providers establishing relationships with existing London market insurance and reinsurance players is expected to continue. Lloyd’s in particular is an attractive market for third-party investors, having been run on external capital since its launch, but access to the business may become simpler in future with Lloyd’s new strategy looking to embrace third-party capital.

A.M. Best cites the challenges that it sees ahead for London market insurers and reinsurers:

For 2014, final results will largely depend on the frequency and severity of large losses, and an active U.S. hurricane season could push underwriting results into the red. Strong technical discipline, as well as prudent management of capital and aggregate exposures, will determine which companies are able to absorb any catastrophe losses and maintain capital strength.

How London market insurance and reinsurance companies respond to the currently challenging marketplace and the prevailing threats to their traditional business models will dictate how they fare over the longer-term.

Catherine Thomas, director of analytics and author of the briefing, explained; “A.M. Best anticipates a greater divergence in the competitive position of market participants. Those companies that are flexible and better able to leverage their specialist expertise will likely emerge in a stronger position.”

You can find a copy of the full report over on the A.M. Best website (login may be required).

Read some of our other recent stories on A.M. Best’s latest reports on the reinsurance sector:

– Hedge fund reinsurers ‘not a new business model’, says A.M. Best.

– A.M. Best turns negative on reinsurance sector, joins other rating agencies.

– 2014 re/insurance M&A sees trend towards global diversification: A.M. Best.