More capital, but less risk, as centralised reinsurance buying bites: A.M. Best

A recent report by ratings agency A.M. Best examining the dynamics of Europe’s 20 largest cedents’ reinsurance purchasing operations, highlights the increasing issue of abundant reinsurance capital but with less risk to underwrite, as centralised reinsurance buying bites.

The report, titled “Europe’s Largest Cedents Alter Reinsurance Purchasing Practices,” discusses the impact of the abundance of alternative capital entering a market that already holds substantial traditional reinsurance capacity.

A.M. Best’s report particularly highlights the growing volume and potential longevity of alternative capital in the reinsurance space, which alongside changes in large cedent buying habits is effectively reducing opportunities for reinsurers.

“Alternative capital is still entering the global reinsurance market, despite cedents becoming stronger in terms of their negotiating powers and some concerns that new participants may struggle to fulfil their business plans,” explained A.M. Best.

A (super)abundance of capital that’s creating pressure on the market has been a common discussion over the last 12 months in particular, and while it adds further stress on reinsurance pricing, the extra capital could be put to good work in emerging markets and innovative schemes, ultimately alleviating some of the negative pressures.

A.M. Best notes the significant alternative capital that is currently available to reinsurers globally, stating; “To an extent, the leading reinsurers can benefit from the inflow of alternative capital, with some of the traditional carriers investing in and sponsoring new ventures.”

Capital market players, including insurance-linked securities (ILS) funds, pension funds, hedge funds and catastrophe bonds is an area well suited for Europe’s largest re/insurers, confirmed A.M. Best.

The larger cedents are in a position where they can utilise the capabilities of alternative risk finance tools, like sidecars and cat bonds, forming a complementary partnership that sees some of the expanding capital put to work.

While the use of such risk financing tools will provide some welcomed capacity reduction, the diversification offered to funds and investors is of growing importance in an increasingly competitive sector.

And for reinsurers these new tools may help them to grow and tap into new markets, which would bring benefits in an era of sometimes shrinking underwriting opportunities.

“Reinsurers should be able to achieve better margins in new areas of business where they can demonstrate some differentiating element,” advised A.M. Best.

Certain large cedents already utilise the benefits of the alternative reinsurance market, with many of the largest cedents discussed in the report having been involved with the issuance of a cat bond, or collateralized reinsurance scheme at some point.

And as 2014 saw cat bond issuance level records broken, at $8.8 billion, that particular element of the alternatives market only appears to be getting stronger and bigger.

Although looking to new, innovative and diversified ventures is one way of improving margins and remaining relevant, A.M. Best notes that over the past few years re/insurers have been seeking to improve the efficiency of capital management, and the reduction of their technical costs.

“This has been achieved by players that benefit from significant diversification by centralising the group reinsurance purchase at the ultimate parent level, or by establishing dedicated reinsurance operations and utilising captives,” said A.M. Best.

Data provided by the ratings agency shows that softer reinsurance rates and increased retention at group level, were a main driver in the 8.2% decline of non-life reinsurance premiums ceded by Europe’s largest 20 firms in 2013. While for the same period the same companies gross written premiums increased by 0.3%, with retention levels for these re/insurers increasing by 1.2 percentage points from 2012 (86.4%) to 2013 (87.6%).

The benefits the current low reinsurance rates are providing for Europe’s top firms are helped by the increasing amount of centralised reinsurance purchasing at group level, the study finds.

As market pressures continue to dent companies achievable returns levels, the establishment of centralised, dedicated reinsurance management can significantly cut costs, while enabling greater retention of underwriting earnings.

A.M. Best uses the example of AXA and its two dedicated reinsurance subsidiaries, AXA Global Property & Casualty and AXA Global Life & Savings, and they aren’t the only ones that have successfully implemented programmes like this.

By placing the entirety of its reinsurance programmes under a single unit, a firm can look at their operations in a more holistic nature. This should reveal potential areas for growth and likewise regions where less reinsurance coverage may be needed, thus reducing costs and realising savings.

This provides companies with a more comprehensive view of their risk exposures, ensuring they can pull-back on regions or sectors that aren’t achieving desirable returns, ultimately helping them to spend less on reinsurance and retain a greater capital level.

The more re/insurers centralise and rationalise their reinsurance agreement operations, the less risk is ceded to reinsurers as retention levels rise. So while there’s more capital, in the form of alternative and traditional reinsurance, centralisation of buying ensures there’s also less risk in the market.

Discussing increased reinsurance purchasing centralisation, A.M. Best said; “Improved risk management is enabling greater control of group reinsurance expenditure, better monitoring of counterparty credit risks and less potential for unexpected loss at a subsidiary level.”

And this isn’t the only area large primary insurers are looking at in order to cut costs and hit desired returns, as a growing number of companies continue to turn an eye to the use of internal vehicles, such as captive-style sidecars, as a means of accessing the third-party capital, reducing reinsurance costs and optimising their cost-of-capital.

A.M Best’s report shows that reinsurance market trends and the structural change the sector is experiencing are continuing to apply the pressure on incumbents.

Too much traditional capacity, growing alternative capacity, less risk ceded to underwrite, large insurers now looking to cede less in search of centralised buying efficiency and insurers also looking to tap third-party capital as a means to almost self-reinsure. The end result is difficult times for those seeking opportunities to deploy their abundant capacity.