The reinsurance market continues to face secular and cyclical decline, according to analysts at global investment firm Bernstein and, despite all the evidence of growing demand, there is an expectation that it will be exceeded by the growth of capital in the sector.
Appetite for underwriting of catastrophe reinsurance risks shows no sign of diminishing, either among the traditional reinsurance fraternity or among the relative newcomers from insurance-linked securities (ILS) specialists and managed funds focused on the space.
The continued low levels of major loss activity, combined with excess traditional reinsurance capital and ongoing interest from the capital markets in the form of ILS and alternative reinsurance capacity sources, promises to easily soak up the additional few billion dollars of demand that have been seen in the run up to the key mid-year renewals.
Despite the evidence showing an increased demand from Florida insurers and the Florida Hurricane Catastrophe Fund, as well as the expectation that under-insured or government backed demand will grow in the future, Bernstein’s analysts say its insufficient to ward off the current challenges.
“We expect the supply of reinsurance capacity will exceed demand growth over most investible time frames, absent any game changing event. As such, we’re expecting CAT prices will remain under pressure, even if the pace of decline slows, and our current expectation is for CAT prices to be off around 10% at the mid-year renewals,” the analysts explain.
On top of the pressures in catastrophe risks, there is evidence that this pressure is increasingly spreading to other lines of business, such as casualty reinsurance, as well as the emergence of sidecar style reinsurance ventures like ABR Re and other initiatives.
As a result, Bernstein’s analysts are favouring primary insurance players over reinsurance companies, when making recommendations to clients currently and expect reinsurers to underperform.
The analysts said; “With the terms of trade likely to remain in favor of reinsurance buyers, we have a strong preference for primary lines names that benefit from cheap reinsurance, and expect reinsurers to fundamentally underperform their primary market peers for some time.”
With reinsurance businesses expected to underperform it’s no surprise that reinsurers, and increasingly ILS players, are seeking ways to access risks more directly, either by writing primary insurance in the case of reinsurers, or by working with fronting companies to access risk for ILS managers.
The natural conclusion of the “dramatic industry wide margin compression” in catastrophe reinsurance is an expectation of lower returns on equity, according to the analysts, who expect this pressure to spread more aggressively now into the Lloyd’s and casualty reinsurance markets.
The imbalance between the demand for reinsurance protection, particularly catastrophe covers, versus the supply of reinsurance and risk capital is clearly exacerbating the issues and causing declines in prices to perhaps be more prolonged than at first thought.
Signs of price stability that have emerged, particularly in catastrophe bonds but also on some traditional reinsurance renewals, perhaps signal a market floor, but on highly commoditised, peak zone risks, the pressure is expected to persist, albeit at a slowing pace.
Until the insurance and reinsurance markets can find a way to unlock the demand from under-insured, uninsured and government or development focused risk capital needs, the imbalance may persist.
It’s worth noting that the world’s largest reinsurance firm Munich Re recently said that it believed demand was keeping up with the amount of capacity building up in the market. That may have been true for a broadly diversified player like Munich Re, but is perhaps more difficult to see for more narrowly focused reinsurers.
As the Bernstein analysts have said before, industry capacity is driving the reinsurance cycle, while in some cases the least conservative underwriters are setting the price. That trend could well continue as long as demand remains insufficient to absorb all the capital that is already in, or interested in, the reinsurance market.
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