Pressures from ILS & reinsurance mounting in primary lines: A.M. Best

by Artemis on June 20, 2016

Reduced profitability across reinsurance business has seen global reinsurers adjust portfolios to focus on slightly more attractive primary lines. But as headwinds continue to mount and the softening landscape persists pressure is growing in this sector too, according to ratings agency A.M. Best.

With rates continuing to decline throughout reinsurance business lines at recent renewals, albeit at a slower pace in more recent times that seen in 2015, reinsurers are increasingly looking for ways to boost returns.

As a result of the impressive growth of the insurance-linked securities (ILS) space in recent years, that to date has mainly focused on property catastrophe business owing to easier entry and well-modelled and understood exposures, this sub-sector of the reinsurance market has witnessed the steepest declines.

As a result of the intense competition at renewals for property catastrophe reinsurance, companies have been seen to adjust their portfolios, pulling back on the most competitive lines and looking to deploy into more attractive, and less competitive areas.

“Due to hyper-competition for reinsurance opportunities limited in number by the strong balance sheets of primary insurers, portfolios of global reinsurers are being weighted more toward primary business.

“Pricing for this business is a little more attractive than on the reinsurance side, although increased pressure is mounting in this sector as well. Over the recent term, property pricing pressures have become more acute, even on the primary side,” said A.M. Best in a recent report, ‘Global Reinsurers Continue To Withstand Challenging Market Dynamics.’

With property catastrophe pricing under such significant pressure for a prolonged period, more and more reinsurers have sought to shift their business towards primary lines in order to improve returns. And, absent a major, market-changing event or a series of large events that would remove a substantial volume of market capacity, it’s likely this trend will continue further into 2016.

Perhaps offering a respite from the doom and gloom that surrounds the current reinsurance market, and in particular the property cat space, catastrophe losses in the opening months of 2016 have increased somewhat, when compared to 2015.

The devastating Fort McMurray wildfire, a series of earthquakes in Japan and other parts of the world, along with extreme weather events in parts of the U.S. and beyond, have caused losses in the billions of dollars.

However, it’s unclear whether this will have any influence on pricing in the property catastrophe space, a notion highlighted by A.M. Best.

“It remains to be seen how meaningful, if at all, the impact of catastrophe losses suffered during the first quarter and extending throughout the second quarter, will be on both the primary and reinsurance market for property.

“The inflow of capital from the insurance-linked securities (ILS) market, especially for U.S. natural catastrophe business, again contributed to the competitiveness of the market,” said A.M. Best.

Historically, ILS capacity has been utilised by insurers, reinsurers, and also non-insurance entities such as pension funds, as part of their renewal process or for retrocessional needs. But as the mechanisms and investors within the space have grown in sophistication, creating a mature marketplace, ILS funds and managers are increasingly looking to access primary insurance risk more directly.

An example of this can be seen with Nephila Capital, an ILS manager that has a real focus on a more direct route to the original source of risk, which Artemis discussed recently as a means for the firm to generate attractive returns and providing greater value to its investor base.

So not only is the trend of reinsurers shifting their business mix to be weighted more on the primary side intensifying competition and mounting pressures on primary property business, but it’s also possible that ILS funds and managers’ desire to get closer to the original risk is starting to contribute as well.

A.M. Best expects pricing in the property catastrophe reinsurance space to remain under pressure in 2016, with rate movements at recent renewals suggesting a pricing floor is yet to be reached.

With this in mind it’s possible that reinsurers will continue to weight their portfolios towards primary lines as they seek to avoid the reduced returns and competitive nature of the reinsurance marketplace.

And with ILS funds and managers continuing to strive for greater returns also, and increasingly finding ways to access primary sources of risk more directly via innovation, the pressures for both the reinsurance and primary markets could intensify further in the coming months.

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