Reinsurance rates to fall at 1/1, tailored solutions an opportunity: RBC

by Artemis on December 14, 2016

Analysts at RBC Capital Markets expect European reinsurers to experience further price declines at the start of 2017, but also sees some opportunity for more attractive returns in tailored solutions, an area that is likely to witness increased demand.

Reinsurance industry capital from both traditional and alternative sources remains in abundance, and while losses have heightened in more recent times, there’s been a lack of “truly market changing losses,” says RBC, suggesting a continuation of the softening landscape as headwinds persist.

Reinsurers of all shapes and sizes are finding underwriting profitability increasingly difficult to find, and with combined ratios creeping ever closer to 100%, some in the space have suggested that were it not for reserves and the benign loss environment, the majority of market players would likely already be in unprofitable territory.

“The major problem for the industry is the glut of capital that has built up in both traditional and alternative markets and which shows no signs of going away. This record level of capital has been a major cause of pricing reductions in our view. Without a shock capital market or catastrophe loss, we see little sign that pricing will turn meaningfully in the near term,” says RBC, in its recent European Insurance 2017 – outlook report.

As highlighted earlier in the year by RBC, and again in its most recent report, ROEs will need to fall to 5% above the risk free rate for prices to materially move upwards, something which hasn’t happened since 2011 and, based on RBC’s “forecasts for normalised large losses and investment returns, this will not be the case in 2017E.”

“One of the difficulties for reinsurance pricing is that the return hurdles that are demanded by capital markets have tended to reduce as interest rates have fallen. Typically returns are anchored to a spread above a risk free rate to reflect the investment backdrop,” explains RBC.

Despite rising combined ratios on a normalised basis and the resultant reduction on margins, RBC still expects to see small price reductions at the key January 2017 renewal season.

To offset some of the doom and gloom RBC explains that tailored solutions could be an opportunity for European reinsurers to achieve more attractive returns, and expects demand for such business to grow in the coming months.

“We expect that demand for tailored transactions will continue to increase. Having sufficient expertise, capital and connections needed to source and fulfil these deals is limited to only a handful of players in our view.

“With the US economy likely to see increasing economic activity along with rising infrastructure spending, we see Swiss Re and Munich Re as well placed to take advantage of new opportunities that might arise,” said RBC.

Interestingly, RBC notes that despite combined ratios trending towards 100%, the duration of risk combined with the capital allocated to underwrite a risk is ignored in the ratio. Tailored solutions with a longer duration should receive a higher discount rate, meaning that the “economic combined ratio of this business is lower than reported combined ratios.”

“In a world where economic capital and earnings are becoming a more integral part of earnings, the economic value generated by transactions will become more important in our view,” said RBC.

It’s not surprising that RBC expects to see further price declines in the reinsurance sector at 1/1 2017, after all, the market remains extremely challenging and competition remains intense. But it’s promising to hear that there could be opportunities for some in the space to take advantage of their ability to participate in tailored solutions, a trend that RBC certainly feels will become more prevalent in the coming months.

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