Alternative capital influences risk tolerances in P&C re/insurance: Kroll

The growth of alternative capital in the reinsurance industry has had a “substantial influence” on risk tolerances, particularly among P&C insurance and reinsurance players, according to Kroll Bond Rating Agency (KBRA).

In an outlook for property casualty insurers for 2016, KBRA examines some of the market developments that have impacted insurers, including the abundance of reinsurance capital, the reductions in the cost of reinsurance capacity and the way that influences insurer behaviour.

As 2015 nears its close P&C insurers are looking forward to another profitable year, the third in succession for U.S. P&C, as low levels of major catastrophe losses help insurers to negotiate other market forces, such as price softening that has spilled over from the reinsurance market and the challenging investment environment, to maintain earnings performance.

The build up of excess capital continues apace, with KBRA noting that because of the continued favourable earnings environment industry surplus for P&C insurers is expected to be at or near all time highs at the end of 2015.

P&C insurers are facing significant price competition, as is being seen in many industries KBRA note, but in insurance the overspill of capacity, competition and interest in risk from the reinsurance space is ramping up the pressure.

Over the course of 2016 and into the first-half of 2017, KBRA expects to see rates trending flat to downwards, with the most evident and significant pressure on pricing in commercial lines, property and of course reinsurance itself.

Through the next 12 to 18 months KBRA says that commercial insurance rates could decline by low to mid-single digits, while property lines of business and reinsurance could see prices decline by another 10% or greater, due to the more favourable loss experience and lack of major catastrophes.

KBRA believes that the pressure on rates is now having a substantial influence on risk tolerances, likely among both insurers and the reinsurers that are most pressured. As a result this is also having an influence on “how insurance and reinsurance is being written” it says.

The lack of losses from wind events may have “led to complacency with regards to catastrophe exposure and overall risk management among some underwriters” KBRA explain. This has also likely been exacerbated by the ability to secure cheaper reinsurance, which could lead some companies to take on undue amounts of risk.

This ties in with a number of themes we’ve been covering on Artemis, ranging from the masking of true reinsurance returns, the need for risk adequate pricing, the decline in returns on equity (maybe below the levels that are made visible, due to this masking), the threat from a return to more normalised levels of catastrophe loss, the use of reserves to boost or protect ROE’s as well as the fact that 2016 renewals and results may actually be worse than expected for reinsurers.

Of course, until the music stops or the major losses accumulate, it’s very difficult to forecast which companies could be facing a more difficult time than others. But difficulty remains in market conditions in reinsurance and is spreading increasingly into insurance lines and, once again, efficiency and the ultimate cost of risk capital are still growing in importance.

Hence continued disruption seems assured in 2016, as globally diversified re/insurers wield their ability to deploy capacity at lower return, while efficient capital markets and ILS players demonstrate the benefits of gaining more direct access to the sources of risk for their capital market sourced capacity.

While some analysts expect that the steady slow down of rate declines and eventual stabilisation of pricing in reinsurance, as it nears a floor for risk appetite, will benefit returns-on-equity the matter of discipline, risk tolerances and potential for over-exposure will continue to rear their head for some players.

So in 2016 expense efficiency will continue to be a key theme, as to will the ongoing rationalisation of reinsurance and retrocession buying. Alongside that the use of internal sidecar, funded captive type reinsurance vehicles, is likely to increase and partnerships with capital market investors could become an opportunity for traditional players to improve their cost of capital efficiency.

So the risk that some players could face an outsized share of future loss events, if indeed they have adjusted their risk tolerances or insurance and reinsurance underwriting practices due to market forces, remains.

But until we see some major events occur and while returns remain attractive for investors it is hard to see where discipline may have waned. That’s going to make 2016 and beyond very interesting to watch and should keep senior management teams in the re/insurance and ILS industry on their toes.

Also read:

– Market pressures to be evident in reinsurers 2016 results: Moody’s.

– Reinsurance may be ‘uglier’ than expected in 2016, negative outlook: A.M. Best.

– Reinsurance pricing floor yet to be reached: Fitch Ratings.

– Re/insurance rate pressure may be greater than forecast in 2016: PwC.

– Re/insurers can expect “much of the same” at January renewals: Wells Fargo.

Read all our reinsurance renewals news and analysis here.