Evolving market, changing dynamics may end the traditional cycle: Willis

by Artemis on October 22, 2014

The evolving insurance and reinsurance marketplace, with further softening in property and casualty risks expected, and the changing dynamics currently underway may spell the end of traditional market cycles, according to broker Willis Group.

Forecasting continued pressure in the property side of the commercial insurance market, Willis expects low levels of loss activity combined with continued interest from new and alternative sources of capital will fuel additional downward pressure on commercial property insurance rates according to the broker’s latest Marketplace Realities report.

At the same time Willis expects casualty rates will also succumb to pressure created by the current market dynamic, with slowing upward rate pressure expected and a chance of softening across the casualty market through 2015.

In essence, Willis expects that commercial insurance buyers will face improving pricing conditions throughout 2015, with further softening in the property insurance line, as well as an influx of new capital from non-traditional sources and an easing of pricing pressure in the casualty market, all combining to a generally soft 2015.

This expected continued softening, availability of new or alternative capital, as well as evolving insurance and reinsurance market, may spell the end of the traditional market cycles as we know them, according to Willis. The influx of new capital, both traditional and non-traditional, to the insurance and reinsurance sector remains steady and this is now pressing on the primary insurance market, according to the broker.

A belief that the re/insurance market cycle as we know it may have gone forever is becoming more widely held. Some suggest that we may never see the same spikes in pricing post-catastrophe event that we have seen in the past, while others suggest a more muted affair. There is also an ongoing discussion in the re/insurance market regarding reinsurers ability to recoup ‘payback’ for losses they suffer, with many now believing that this concept is antiquated in a modern marketplace and that re/insurance should be priced commensurately with the risk, not a companies desire to recoup previous losses.

Willis experts suggest in the report that even after a mega-disaster or large catastrophe loss event, a softening market may actually become softer or at least maintain its downward momentum today. Also, in the absence of a major loss Willis experts suggest that the softening could accelerate, heading for the ‘Edge of a cliff’ as the report is titled.

The report cites the “abundant alternative sources of capital”, which Willis says do not appear poised to exit the market at the first sign of a loss, as one of the key factors behind this.

A large event could in fact attract more non-traditional investors seeking higher returns based on the expectation of rising rates, helping to maintain downward pressure on the market,” Willis believes.

Matt Keeping, Chief Placement Officer of Willis North America, commented on the themes in the report; “With policyholder surplus at record levels, insurers are increasingly in position to compete for business on price. With opportunistic capital continuing to show interest in the insurance sector, we wonder if the traditional cycles of hard and soft market might be changing. A mega disaster with insured losses of $50 billion, or even more, might not turn the market, with eager capacity flooding in to take advantage of what would normally be a rate hike following such a loss. Absent such an event, we can easily imagine scenarios where rate softening accelerates and rates go over a cliff – or at least approach the edge.”

Willis says on commercial insurance rate prospects:

Willis expects commercial Property rates to fall by an average of 10–15% for both non-catastrophe-exposed and catastrophe-exposed risks. Property Rates have been falling for several consecutive quarters and Willis does not see an end to this trend.

For commercial Casualty lines, capacity remains abundant but carriers continue to redefine their appetites. Willis expects primary Casualty pricing to range between -10% and +10%.

Willis is forecasting workers compensation rates to range between -5% and +5% and as much as +8% in California. However, California Workers’ Compensation is seeing its lowest increases in years and other states are applying for lower rates for 2015.

The stand-alone Terrorism insurance market has experienced a capacity boost, which is driving rates down in low-risk zones, another notable sign of marketplace softening.

Willis product line experts see rates declining in five commercial insurance lines for most buyers: Property, Marine, Surety, Terrorism and Trade Credit. Flat rates or a mix of increases and decreases are expected in seven lines: Casualty, Workers’ Compensation, Auto, Environmental, Directors & Officers, Errors & Omissions and Health Care Professional, or Medical Malpractice. Modest increases are predicted in seven lines: Aviation, Construction, Political Risks, Employment Practices Liability, Fidelity, Fiduciary and Employee Benefits.

This forecast of commercial insurance rate trajectory for 2015 will not make easy reading for some insurance and reinsurance company executives. With rates already down in some lines and further softening now seeming inevitable, there will come a point where rate adequacy becomes a concern for underwriters.

When rates are no longer adequate for insurers or reinsurers to meet their cost-of-capital, or fall below the point where re/insurers believe technical pricing to be, the pressure is set to ramp up considerably. This is the point in the markets evolution where desperation may kick in, as some seek to maintain premiums at any cost as they struggle to maintain returns for their investors. If we saw terms and conditions broadening in 2014, as reinsurers sought to secure signings, 2015 may see them stretched to the limit if rate softening continues apace.

While Willis says that rate softening could accelerate and head off the edge of the cliff, there has to come a point where responsible underwriters will either set their base price for a risk or peril, or choose to walk away entirely from certain areas of the market.

As we wrote yesterday, with capacity driving the reinsurance market cycle (at least to a degree) the market or underwriter who is least conservative may be setting the price. However, that as a strategy cannot last. You cannot under price risk and get away with it forever. Underwriting at a level below the technically accepted base price for a risk or peril can only end in disaster, particularly for those whose cost-of-capital is still high (we’re thinking traditional reinsurance players here).

Granted, some insurance-linked securities (ILS) players have a much lower cost-of-capital, given their more efficient business models, leaner teams and ability to increase and shrink their capacity in an agile manner as market conditions allow. However, even for these players there is a baseline price for assuming risk. Of course an ILS players baseline may be lower than a traditional reinsurers and trying to compete with that definitely has dangerous connotations.

Willis believes that the buyers market is something to be taken opportunity of. Keeping commented; “For insurance buyers and risk professionals, now is the time to think about the strategic possibilities as renewals approach. Work with your insurance broker to optimize your risk management investment and protect your business.”

Willis is steadily becoming increasingly bullish on the staying power of alternative reinsurance capital and ILS in the market, even in the face of major losses which cause traditional insurance capital to shrink.

Keeping explained; “The new capacity seems so eager and steady that even in the face of a mega disaster, we do not see a withdrawal of that capacity. On the contrary. Anticipating a rise in rates, which usually follows a huge loss, more capacity might come in. That could well counter the withdrawal of capacity by insurers paying out the mega claims for the mega loss, and rates would continue to decline.”

But this is actually a good thing for the traditional players, says Keeping, as new capital will help to protect their balance sheets and if leveraged wisely could also be used for growth.

“Insurance carriers are likely to be able to withstand these conditions. They are becoming more efficient and more stable as a result of improved balance sheets and the access to additional forms of capital,” Keeping said.

So the outlook continues to look bleak for those insurance or reinsurance firms who would rather stick their heads in the sand than find ways to adapt and embrace the new re/insurance market paradigm. With the expectation of market softness persisting into 2015 and that softening expected to broaden considerably in insurance lines, no doubt exacerbating reinsurance market softening, the search for rate and premiums will continue and the pressure looks set to increase.

The traditional re/insurance market cycle may never be the same again. The market cycle and the market’s dynamic may be unrecognisable in years to come. Perhaps that calls for a new wave of insurers and reinsurers which are unrecognisable from those we see in operation today?

You can access a copy of Willis’ Marketplace Realities report, titled “Edge of a Cliff?”, in PDF format here.

Further reading:

Will pension funds, alternative capital & ILS kill the reinsurance cycle?

Innovate or perish. A message for insurers and reinsurers from Aon.

A smarter, more client-responsive reinsurance market: Willis Re.

Differentiate or consolidation ahead for reinsurance industry: PwC.

Innovate & adapt to navigate a reconfigured reinsurance industry: S&P.

Structural change, lower margins, a deeper reinsurance convergence.

The death of the traditional catastrophe reinsurance model.

Institutional investor appetite for insurance linked assets remains strong.

Pension funds still only dipping their toes into ILS and reinsurance.

Still early days for pension fund allocations to ILS and reinsurance.

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