Reinsurance returns challenged if capital inflows continue: A.M. Best

by Artemis on April 21, 2015

Returns for major reinsurance companies around the world will be increasingly challenging to achieve if capital continues to enter the market at recent high rates, reserve releases soften and pricing continues to decline through 2015, according to A.M. Best.

The latest global reinsurance market report from rating agency A.M. Best contains little in the way of solace for reinsurers that are feeling under pressure. In fact it suggest that the pressure is set to continue through 2015 and indeed intensify, as long as market conditions remain similar to how we see them today.

Publicly traded reinsurance firms saw their stocks ending 2014 below the market, as concerns about the decline in reinsurance pricing continued to impact investor and shareholder sentiment, A.M. Best notes. The average share price increase for 2014 of the group of global reinsurers that A.M. Best tracks was just 6.5%, well below the normal ROE levels they promise to investors.

Regardless of continued low levels of major and catastrophe losses, pricing pressure remained evident right throughout 2014, A.M. Best highlights. Further price declines have been report again at the January and April reinsurance renewals and more could be ahead for the key mid-year renewal season.

The “dramatic price declines” witnessed in 2014 and at the January 1st 2015 renewals continue to be attributed to a “lack of market-changing losses, as well as increased retentions carried by ceding companies and the abundance of capital in the market,” A.M. Best says. With no signs of these trends ending or slowing down, the challenges to reinsurance returns look set to continue.

Management teams at reinsurers continue to assure that discipline remains and that they will reduce their books as necessary. Evidence would suggest not all the management teams are being entirely truthful here, given the competition based on price and terms or conditions that has been apparent at recent renewals.

Reinsurance companies largely agree that 2015 will remain very challenging and result in an even more careful approach to risk selection, A.M Best says. As a result large reinsurer portfolios are likely to continue to weight towards primary insurance and specialty lines or casualty risks.

Expectations are that reinsurance companies will maintain their strong levels of capital through 2015, perhaps increasing them further if losses remain at recent low levels. The abundance of traditional capital is expected to continue to push management teams to return it, or perhaps to look to deploy it through mergers or acquisitions.

Reinsurance pricing in 2014 was down double-digits and January, followed by April, have both show further declines of 5 to 15% on many lines of business, depending on risks, geography and recent loss experiences.

A.M. Best says the expectation is for further pressure on reinsurance pricing throughout 2015, given the continued pressures from alternative and third-party capital, as well as the total lack of price changing loss events in recent years.

Third party capital is expected to continue to enter the market, according to A.M. Best, as investors such as large pension funds and hedge funds seek to leverage insurance linked assets as diversifiers and return drivers for their portfolios.

Given the market environment both reinsurance and retrocession pricing in the United States is expected to remain under particular pressure going forwards, especially as these are the lines of business and region where the competition from insurance linked securities and alternative capital is the highest.

A.M. Best notes that while property catastrophe reinsurance remains the most pressure line, it is seeing softness in lines such as U.S. motor, engineering, global trade credit and personal accident.

As companies seek to avoid the highest levels of competition the pressure will continue to spill over into other parts of both the insurance and reinsurance business. This in turn results in more upward pressure on ceding commissions on quota shares and leads to more use of multi-year contracts, broader terms and conditions and increased signings on aggregate covers, A.M. Best notes.

“For 2015 returns are expected to get increasingly more challenging if capital continues to enter the market at such high rate, reserve releases decline and pricing continues to soften in the double digits,” A.M. Best said.

There is no sign that capital inflows into insurance-linked securities and insurance-linked investments will slow. In fact, signs point towards renewed and widening interest among institutional investors, plus new efforts from ILS managers to create new business strategies and structures to allow them to put more capital to work.

With that in mind it is hard to envisage the pressure applied by third-party capital and ILS letting up any time soon. All the forecasts are for continued growth of ILS and alternative capital in reinsurance, so reinsurers will need to adapt to this and embrace it, although that won’t guarantee their returns.

Finally the rating agency highlights the potential for lower returns on equity to occur at the same time as an uptick in combined ratios, due to commission expense increases and premium declines occurring at the same time.

If the loss experience also upticks through 2015, even if not sufficient to cause a major market wide loss, it could put some reinsurers under particular pressure, as returns could rapidly start to look very unattractive.

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