Overcapacity in global reinsurance set to continue: JP Morgan

by Artemis on June 5, 2015

Overcapacity in the global reinsurance space is set to continue, with traditional and alternative or ILS capital likely to expand as insurance and reinsurance are increasingly institutionalised as an investible asset class, according to a recent report from JP Morgan.

JP Morgan’s report examines the impact on global reinsurance capacity of relatively benign catastrophe losses in recent years and the affect this has on Lloyd’s participants, alongside the influx of alternative reinsurance capital and growth of ILS markets.

“A period of benign losses and growing reinsurance capacity has resulted in arguably the most challenging pricing backdrop that the sector has seen in some time, with reinsurance and larger ticket lines particularly affected,” explains JP Morgan.

The influx of alternative reinsurance capital in the global reinsurance sector has been a constant discussion over the past few years; with reinsurer Aon Benfield predicting that the volume of alternative capital in the sector will reach $150 billion by 2018.

The JP Morgan study highlights the influx of third-party reinsurance capital but also notes that traditional reinsurance capacity has increased steadily too, “and in absolute terms it continues to add the greater amount to capacity.”

Expanding on this, the report states that this trend is expected to continue, and while the bulk of reinsurance capital continues to be traditional in nature, the cat bond market keeps growing and “the most significant growth in recent years has been in collateralised reinsurance vehicles,” says JP Morgan.

This has resulted in a greater parity between the features of coverage available from different types of capital and reinsurance structures, as alternative capital and ILS seeks to operate on a level playing field with traditional reinsurance.

This point was highlight recently by Hilary Paul of LGT ILS Partners, who said that the lines between ILS, and in particular collateralised reinsurance, and traditional reinsurance are “greying more and more,” covered at the time by Artemis.

Arguably the most notable impact of overcapacity on the reinsurance industry is the resulting pressure on reinsurance rates, and the impact this has on certain primary lines as the negative pricing trend filters down, in particular impacting property catastrophe rates.

And there’s potential for this to spread further and move beyond catastrophe exposed lines, explains JP Morgan; “First, alternative capital (in its newer structures) is more capable of accessing a wider universe of risks, and second, as underwriting prospects deteriorate in catastrophe lines, traditional participants may choose to reallocate capital to other markets.”

And it’s not just rates that overcapacity in the reinsurance sector is having an impact on, explains JP Morgan, “it has also allowed buyers of cover (and brokers) to be more selective in choosing insurance providers,” the firm explains.

Clarifying that buyers and brokers generally desire to work with fewer reinsurers, in greater size, to reach the same goals at the end of the line, meaning that overcapacity has led to reinsurers seeking greater relevance, resulting in a growth of merger and acquisition (M&A) activity amidst fears of being left behind.

The report explains; “Clearly, this provides a rationale for consolidation, and we believe scale will continue to be deemed a necessary trait for success in the industry. As the presence of alternative capital continues to increase, we believe this desire to “stay relevant” will continue to provide a motivating factor for M&A.”

Looking forward JP Morgan states that the growing prevalence of alternative or third-party capital in reinsurance and ILS is most likely here to stay.

“Growing sophistication of pension funds and other investors seeking uncorrelated returns has boosted the appetite for insurance-linked securities (ILS), and we believe (re)insurance is increasingly becoming institutionalised as an investible asset class,” notes the report.

Concluding; “For this reason we believe fears that alternative capacity will exit the industry promptly following a significant catastrophe year are exaggerated, and that the industry should be able to recapitalise quickly (from both traditional and alternative sources) following a significant loss-making event.”

Overcapacity is likely to keep downward pressure on reinsurance rates although, as yesterday’s news on the June renewal showed, perhaps at a lower rate of decline in future. One positive aspect of overcapacity is that capital is always available should new underwriting opportunities arise. For reinsurers the difficulty is going to be in generating, or finding, those chances to deploy excess capacity.

Also read:

Niche lines, capital efficiency benefit Lloyd’s re/insurers: JP Morgan.

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