Alternative capital remains a key reinsurance pressure: UBS

Alternative capital remains one of the key pressures facing the reinsurance industry, according to analysts at UBS, albeit that overall the cyclical pressures reinsurers face have reduced slightly.

Cyclical pressures persist, the analysts explain, as global reinsurance markets remain over-capitalised and with no sign of that reversing.

Today, equity analysts at investment bank UBS said that they have turned more negative on the European reinsurance and London market re/insurance sectors, as fundamentals continue to look poor and pricing has not stabilised in January as many had hoped for.

Alternative capital and its continued growth, albeit at slower rates in 2016, remains one of the key pressures which is affecting the outlook for traditional reinsurers in 2017 and beyond.

Not only is alternative capital helping to boost industry capital levels, alongside excess traditional reinsurance capital, but the ILS fund managers wielding the majority of the alternative capital base are becoming increasingly specialised, expansive and competitive, both in the renewal market and outside of it as they seek to access risk more directly.

Supply of reinsurance capital continues to exceed demand, UBS’ analysts note, resulting in ongoing pressure weighing on pricing. This pricing pressure is now felt widely across the industry, as after a number of years where capital has continued to stay at excess levels pressure has spread far beyond the property catastrophe reinsurance market where it was first evident.

“Supply is running at a material excess driven by alternative capital seeking diversification and abundant traditional capital that has built up in a benign loss environment,” UBS’ analysts explained.

Margin pressure as a result of declining prices is beginning to become apparent in reinsurers results, as seen in the last quarterly filings, and with the catastrophe bond market having reached another record size while alternative capital also grew to a new record recently, the prospect that any of this pressure will be released seems slim.

The key January reinsurance renewal season “dashed hopes of pricing stability” UBS’ analysts continue, with the majority of lines seeing further declines.

However, one brighter area was once again U.S. catastrophe reinsurance and some bigger ticket property risks, UBS says, which is again interesting (perhaps telling) as the area under most pressure from ILS fund managers and alternative capital once again seems to be the area of the market where the most discipline was seen.

UBS sees “no improvement in the earnings outlook” for the reinsurance sector in 2017, with diversified players perhaps the better picks while specialty players appear the most exposed and less able to manage the market cycle effectively this year and beyond.

So alternative capital remains a key pressure in the reinsurance market, but also the areas of the market where it plays the most are the locations of the most discipline. This is likely as pricing declined in some catastrophe markets so steeply, it has reached a floor more rapidly and so signs of stability emerged more quickly there.

UBS’ analysts provide one final interesting insight into their thinking on alternative capital, for the larger reinsurance firms one of the main ways any upside will be seen is if levels of alternative capital in the market recede somewhat.

For Swiss Re specifically the analysts believe that a reduction in the amount of alternative capital could lead to pricing increases, and this is a core component of their upside scenario. The downside scenario, meanwhile, assumes alternative capital remains resilient.

This shows just how influential the levels of alternative capital and growth of ILS managers are on the reinsurance market today. This influence is not expected to reverse and hence reinsurers need to adapt by leveraging the trend to their own benefits, something not all of them are currently achieving.