For reinsurers the Monte Carlo reinsurance Rendez-vous has provided a fillip, defined as a stimulus to activity, but this is likely to be shortlived say analysts at Keefe, Bruyette & Woods, who say that the risk of disappointment looms large over the sector.
KBW analysts discussed their takeaways from meetings with reinsurance executives in a number of reports this year, finding that the trend looking forwards will continue to be one of competition, falling absolute profits, lower return on equity but with the downside limited by continued capital management and repatriation.
On a global basis, the KBW analysts expect reinsurance rates across the sector to be down by 1% to 2% in January, clearly with some sectors and regions seeing much steeper declines than others, such as U.S. property catastrophe reinsurance which is expected to be down 5% to 10%. The analysts believe that there are enough large underwriters with strong capacity to ensure that the downward trend continues at the renewals.
The risks are growing, not just of disappointment, but also from the continued trend towards softer terms and conditions alongside the softer pricing environment, as well as growing uncertainty about the ability of reserves to remain adequate to compensate and boost current years with prior year releases.
The message from reinsurance executives at Monte Carlo was one of “softening but not soft” markets and as you’d expect there was a reluctance to talk the market down any further, when it is doing a fine job of heading south all on its own.
Profitability of reinsurers is expected to head back to the levels seen in the mid-2000’s, but not yet as bad as the late-90’s. Interestingly, increasing levels of capital management are expected which, with underwriting profits expected to be weaker, means that performance or out-performance may rely on how much better capital management can be to compensate for this, said KBW.
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There comes a point when weaker earnings kills capital management, we think, and so we would still be positioned negatively top-down on this point over the medium-term.
Pressure on terms and conditions is a growing topic of discussion, but at the moment the analysts say that nothing catastrophic is thought to have occurred. We would add there that only time will tell, as some reinsurers adding cyber or terror risks to programs could find themselves very over-exposed should something very bad occur.
Similarly, the ‘wrong’ outside of the risk models storm could potentially badly hit reinsurers that have expanded the hours clause significantly, so again time will tell whether these changes to terms and conditions are detrimental or not. Most will find they are not, but there may be some who it comes back to bite.
We have met more reinsurers that see absolute returns as good enough to allow them to continue to grow to make us feel that most of the comments above carry downside risk.
The above comment comes with regards to pricing and whether it has reached a floor. Many reinsurers still see room for growth which could continue to exacerbate pricing and also see them taking on increasing amounts of risk, given the more relaxed terms and conditions.
KBW found a clear divergence of strategy among reinsurers, with some convinced that absolute returns are good enough to maintain growth, while others pullback or divert capacity to new lines of business. Others discuss the dwindling of positive reserves, while still more suggest that reserve releases will be a structural feature of their returns in quarters to come. Not all can be right, we would note, and there is likely a good dose of bluster in reinsurance executives explanations of strategy right now.
Tiering is a factor, KBW’s analysts say, with some of the largest capacity providers able to secure the best rates and terms, while the smaller become more marginalised and find more pressure on their returns. However, many don’t see this as a challenge and the ones that do clearly aren’t saying right now.
So the risk of disappointment, for reinsurance firms and for their shareholders, remain clear. It’s encouraging to see more talk about the structural change being seen in the reinsurance market, as well as what can be done to innovate and adapt to market trends, rather than purely discussing the growth of alternative capital and whether it is sticky or not.
Sadly, one theme we picked up on at large reinsurer and broker media events, was a continued questioning of whether insurance-linked securities (ILS) market players will pay their claims. Clearly those questioning this are not watching the ILS space closely enough, as if they did it would be apparent that the larger ILS managers all pay claims on a regular basis, given the growing proportion of their portfolios which consist of collateralized reinsurance.
Disappointment is not guaranteed, but for analysts like KBW the upcoming third-quarter earnings are likely to be telling in terms of combined ratios, expense levels, reserve releases and overall return on equity, as a measure of just how disappointing the next few years could be for some.
