Reinsurance prices to stabilise, but at structurally lower levels: Goldman Sachs

by Artemis on May 27, 2015

Analysts from Goldman Sachs believe that reinsurance pricing could stabilise by the end of 2016, but warn that this could be at a structurally lower level from where they may not rise much again, even after future losses.

There is an increasing expectation that a reinsurance pricing floor is being reached, with evidence emerging in the insurance-linked securities (ILS) market as catastrophe bonds price at or above the middle of guidance and even some reinsurance placements have had to be repriced to get accepted by the market in time for the renewals.

Equity analysts from Goldman Sachs have also seen the signs that pricing is beginning to stabilise, but they do not expect it to happen as quickly as some reinsurers might like. The analysts forecast reinsurance price stabilisation to come by the end of 2016, but at structurally lower rate levels as abundant alternative capital helps to prevent significant price rises.

The analysts view lower reinsurance pricing as a structural shift, so effectively something that will change the future reinsurance cycle, rather than as a pure cyclical trend. The influence of efficient capital from insurance-linked securities (ILS) players and the capital markets is set to prevent future significant price rises, resulting in a flatter reinsurance cycle.

One of the factors expected to stabilise rates is the fact that returns on ILS and alternative capital have neared historically low levels. ILS investors are only prepared to go so far and cannot compete as strongly based on diversification as traditional reinsurers, hence in many cases they are quicker to push-back on rate declines.

The analysts expect the reinsurance cycle that emerges after the recent price declines to be much flatter and with future price rises moderated by both the abundance of capital, from traditional and alternative sources.

Adding to this moderation of the future reinsurance cycle is the potential for future inflows of capital from third-party investors, should the reinurance market and ILS show any sign of increasing its return potential. This could make future reinsurance price rises short-lived.

All of this means that reinsurance companies are also going to have to get used to earning a lower return on their capital, as with pricing down and competition still high reinsurer returns on equity (ROE’s) will suffer.

“The presence of alternative capital means a structurally lower return for reinsurers,” the analysts from Goldman Sachs explain.

Across the major European reinsurance firms, the world’s largest players in the market , the analysts expect that ROE’s of 14%, as was seen in 2012, are a thing of the past. Despite the fact that pricing declines may moderate or stabilise completely in the next year and a half, the impact of these declines will continue to be felt on ROE’s for longer.

Over the years 2016 to 2019 analysts forecast an ROE of 9% to 10%, for the big European reinsurers, driving home the importance for these firm’s to become as efficient as possible, seek out new opportunities and to perform as well as possible on the asset side of the business.

But what if the reinsurance market sees a major loss in the next year or two?

“The presence of alternative capital means that price increases of the magnitude seen in the past are unlikely. We expect European reinsurance returns to settle at a structurally lower level,” the analysts explain.

The analysts also highlight the “wall of capital” waiting to come into reinsurance should the available returns rise significantly, this too is expected to moderate any future price rises.

It’s not all bad news though, as Goldman Sach’s analyst team believe that, while this is a structural shift in P&C reinsurance, the diversified models of the large European players, long-standing client relationships and ability to provide tailored solutions will insulate them to a degree, keeping returns resilient.

Also, in the future the analysts do not see exponential growth of ILS and alternative capital as likely, rather they expect growth to become more steady and aligned with increases in demand for reinsurance capacity.

For the reinsurance companies reading this, the message from Goldman Sachs analysts is clear.

Expect continued competition and pressure in commoditised areas of the reinsurance market as alternative capital and ILS continues to acquire share.

In less commoditised, more specialised and tailored areas of the market the future for reinsurance firms is brighter, but the pricing environment is likely to have an effect across much of the market, so the potential for lower returns cannot be escaped.

This perhaps lays down a challenge to the ILS players, to become more focused on offering complex solutions in order to access some of these areas of the reinsurance market where reinsurers have recently felt safer.

In a structurally changed reinsurance market, where lower pricing is the norm for at least the next few years, efficiency is going to remain a key trait of successful companies. That will be the case for both traditional and alternative capital, reinsurers and ILS managers.

Using capacity (whether traditional or alternative) efficiently should generate a higher return, ultimately. Therefore those that can find efficient ways to access new business, embrace innovation and provide solutions rather than just pure capacity, should be the ones generating the best return for investors over the coming years.

Also read:

Majority of re/insurers feel industry is over-capitalised: Goldman Sachs.

Pessimistic re/insurers struggle on low investment returns: Goldman Sachs.

Stand-alone reinsurance model may be unsustainable: Goldman Sachs.

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