Reinsurance rates decline at Jan 1, change the only sustainable course

by Artemis on December 31, 2014

Reinsurance broker Willis Re said that change is the only sustainable course of action for many reinsurers, as competition at renewals pushes rates on catastrophe business down by 10%, but some evidence of a price floor is emerging the broker said.

Reinsurers have been under threat from declining rates and pricing across lines of reinsurance business for almost two years now, with little in the way of losses to reverse the trend. 2014 has seen another year of almost record low levels of natural catastrophe losses and the pressure on most lines of business continues.

Continued competition from growing quantities of alternative capital from third-party capital market investors is adding to the pressure and also forcing reinsurers to rethink established business models, as the leaner strategy of ILS managers begins to threaten market incumbents.

It’s wrong to suggest that the inflow of capacity from the capital markets, into instruments such as catastrophe bonds, sidecars and other insurance-linked securities (ILS), alone is causing the pressure to rise for reinsurers, but it is a contributing factor. Added to the excess levels of traditional reinsurance capacity, plus the lower-cost of capital that is now being wielded by ILS specialists, the only natural result is for rates to keep declining.

At the January 1 2015 reinsurance renewals, the key market renewal for much of the globe, natural catastrophe reinsurance rates have continued to decline, Willis Re said. The brokers renewals report, Willis Re 1st View which will be published in the coming days, states that catastrophe reinsurance rates have declined by around 10% for the renewals.

A 10% average decline would suggest that some regions and perils which are more commoditised and under more competitive pressure from ILS will likely have declined much more than this. This will likely be particularly evident in any U.S. catastrophe renewals at 1/1, where rates will be catching up with the steep declines seen at the June 2014 renewals.

James Vickers, Chairman of Willis Re International, told the Financial Times that the rate declines seen are not as steep as those witnessed in other recent rounds of reinsurance renewals. He said that this is partly because insurers are no longer happy to simply take the cheapest offering of capacity as they are keen to maintain a level of quality and reliability in their panel of reinsurance counterparts.

That will bode well for collateralized capacity and ILS players as, for all the discussion of whether they will be here to pay claims in the future, the fact remains that the capacity is fully collateralized and held in trust so it is technically more secure than a reinsurers promise to pay from its balance-sheet or reserves.

If a really serious catastrophe loss occurred it could well be traditional reinsurers that suffered the most and found it impossible to pay, as if they exhaust their reserves they could have nothing left to draw on. For collateralized or ILS capacity, the collateral is held in trust and segregated for a single renewal contract, meaning that other or unrelated claims could not erode a cedents risk capital.

But that all needs testing and while we haven’t had any major catastrophe loss events the levels of capital in the reinsurance industry keep building and along with it so does the level of competition.

Competition will be a theme of the Willis Re report when it is released. The broker said that for many reinsurers there is only one sustainable course of action, to change their direction.

This could be a change of strategy, their business model, their portfolio mix or to look for additional scale, perhaps through M&A. Change is required so that these marginalised reinsurers are not overlooked by reinsurance buyers. This change will provide elements of diversification to the business model, as Willis Re expects that specialising in one area of the market will not remain viable for all but the most effective underwriters and most efficient users of capital.

There is some good news for reinsurers though. Willis Re believes that a pricing floor may be emerging, with reinsurers declining to sign on renewals and less willing to support lower pricing. Vickers told the FT that this is particularly evident on catastrophe lines of business where some reinsurers have been declining to sign based on terms offered.

What is interesting to note is that ILS managers have been declining some renewal contract offered terms for most of 2014. In fact ILS managers have told Artemis that they declined some renewal terms as long ago as last January, while some catastrophe bond focused investors have been declining many of the deals that came to market in 2014.

This is because with a lean, capital efficient, return to investor focused business model, you cannot underwrite lower priced business without damaging your overall portfolio returns. Some traditional reinsurers, meanwhile, have been able to reduce pricing throughout the year as their portfolio diversification and mix has allowed this. It is encouraging to hear that this might be stopping now, at least on some of the most competitive lines of business.

The message is the same as it has been all year though. The larger reinsurance players continue to be able to diversify themselves and switch focus to more profitable lines of business. Smaller to mid-sized reinsurers need to look to diversification by entering new lines, or to acquire scale, or perhaps a total change of business model to pursue growth using third-party capital, to improve their outlook.

2015 looks set to see a continuation of the competitive pressure on reinsurance companies and there will be a continued focus on efficiency and expenses, we expect. The focus for ILS and collateralized players will continue to be on maintaining return targets in a lower priced market while remaining disciplined, with some more diversification initiatives expected to try to grow the market further.

In the reinsurance market of the next few years a number of factors are likely to come to the fore. The cost-of-capital, the efficiency of capital and the mobility of capital are all becoming key for both traditional reinsurance players and ILS specialists.

New business models are already emerging, which see seasoned professionals seeking to leverage the best of ILS alongside their strong relationships built through years of traditional reinsurance business. These new models could be the first signs of a greater separation of the capacity from the underwriting occurring. In the reinsurance market of the future capacity may be pools of capital, with different risk appetites and return requirements, which can be allocated to risks using technology and underwriting skills from specialist service providers.

For reinsurers change is the only sustainable course. For ILS players discipline and steady expansion is likely the best course of action. For companies launching new business models acquisition of market share is key. How big a change comes will likely be defined by how long the competitive market environment lasts, which with the capital markets still extremely interested in insurance-linked investments and ILS could be for some foreseeable time.

The question then maybe isn’t whether reinsurers and the reinsurance business model will change. Rather it may be how much do reinsurers and the reinsurance business model need to change to survive?

How the reinsurance market evolves during 2015 will be fascinating to watch. The January renewals look set to apply further pressure on the established players which perhaps brings even more opportunity for disruptive, new businesses to emerge and take market share.

We’ll be watching closely as trends emerge and look forward to taking you through 2015.

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