Insurance-linked securities (ILS) fund managers are taking a “discerning view” to underwriting risks in Europe, as rate decreases have prevailed and investment managers seek to ensure that investor return requirements are maintained, according to reinsurance broker Willis Re.
The environment in European property catastrophe reinsurance has pushed the ILS fund part of the reinsurance market to apply discipline when it comes to selecting underwriting opportunities, but has also presented a challenge for growth, as the region is a key source of diversifying risks.
“ILS Funds are cognisant of the different client demands in Europe, which combined with prevailing rate decreases, create challenges to growth,” according to Dirk Spenner, Managing Director and Head of Europe North/East/Central, at Willis Re.
The decline in reinsurance rates has left the market discussing discipline, who has it and who doesn’t. For the ILS fund managers, who typically know all of their end investors extremely well, the need to maintain a certain level of return can result in a large number of deals not being suitable to risk/return requirements.
Spenner explained; “The rating environment leaves the ILS Funds taking a discerning view to participations to ensure that they are meeting investor return requirements.”
But the focus on European property catastrophe risks won’t go away in the ILS space, as it remains a key regional addition to portfolios.
“A number of ILS Funds remain interested in writing European business with the aim of diversifying their portfolios. Diversification is partially driven by more recent investor mandates seeking ex-US exposure,” Spenner continued.
The desire and need to remain both diversified on a peril basis and geographically means that ILS fund managers are adjusting strategies when it comes to the European market, according to Spenner, with a number of key trends emerging.
He continued; “Trends observed include ILS Funds moving further away from one homogenous model, offering a growing variety of products in both non-life and life.
“Furthermore, alternative models are being introduced; other funds have tried to become more meaningful and competitive by creating reinsurance underwriting balance sheets to leverage their returns and enable easier business access.”
And the result of the currently less attractive European market is also seen in less direct reinsurance being underwritten, than is seen in the U.S. market, which remains the core underwriting zone for ILS.
“ILS Funds have provided useful and meaningful European retro capacity but have not become as present or competitive as traditional paper in direct business in Europe as they have in the US,” Spenner said.
However, while European reinsurance market conditions can present challenges to ILS fund managers, the traditional players find their business models under continual threat, according to Willis Re.
“Reinsurance purchases are not increasing despite the falling rate environment and buyers continue to consolidate their purchases leading to a continuing decrease in the need for reinsurance capital.
“Traditional reinsurers are facing multiple challenges, despite the continuously positive combined ratios. They have to compete for market share in a more consolidated reinsurance market, stay meaningful in the current M&A environment and maintain a portfolio which is geared to withstand increased Nat-Cat loss frequency.”
The industry is under constant pressure to present positive post-M&A results and achieve their business plan objectives – to grow, be more meaningful to cedants and return positive results to shareholders on the back of ever decreasing risk loadings,” Spenner explained.
Natural catastrophe reinsurance renewals are expected to continue to see the rate of price decline slow down and Europe is no different to the U.S. in this respect. However margins remain thin in Europe for some peak risks, which could affect the attractiveness of the region for some time to come, making careful risk selection vital.
“The current market forces have led to further risk-adjusted rate decreases throughout the majority of territories and across renewal dates. In the absence of major Nat-Cat losses a “market-floor” could not be observed in any of the recent renewal dates, but signs of slowing have emerged,” Spenner said.
He continued; “Our view last year that ‘buyers are in the driving seat’ remains valid in the current market conditions. The greater consistency that markets apply to their view of Nat-Cat risk is making risk loadings for European Nat-Cat treaties more and more transparent. As a consequence price decreases are automatically slowed when rates start approaching pure loss cost levels. This may lead to discrepancies in expectations between reinsurance buyers and sellers for adequate renewal pricing at the 01.01.2016 renewal. However, losses remain at a historic low, significant positive returns are still being achieved and there is still an oversupply of reinsurer capital.
“Considering all these aspects we expect continued risk adjusted rate decreases for European Nat cat treaties. Rate decreases could exceed the general outlook for rate decreases if previous renewal rates have not been in line with general market reductions and / or programmes can be shown to be paying above market loss cost loadings. Reinsurers may again prefer to accept ‘subtle’ risk adjusted decreases, for example, terms & conditions, additional exposures excetera, rather than straight cash reductions.”
“As always, any additional major events, particularly large European losses or other significant economic events, in the latter part of 2015 will impact the pricing views outlined above, but should not create a shortage of capacity.”
As a result of the dynamics in European markets and across the globe, Spenner concludes; “The traditional business model of the reinsurance industry is being questioned and the main challenges for the consolidated risk carrier landscape is the creation of sizeable reinsurance groups with enough balance sheet leverage to withstand decreasing returns. At the same time carriers must remain flexible, innovative and able to meet cedants’ increasing demands for holistic, strategic counter-parties.”
There’s that word again, innovative. Reinsurers and ILS fund managers know that innovation is the best way to climb away from a situation of depressed margins. But equally important is being discerning in the business underwritten. Innovation and discipline look set to be key themes going forwards.
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