Munich Re expects more softening, Q4 combined ratio hit by cats

Global reinsurance firm Munich Re said this morning that it expects that global reinsurance rates and pricing will continue to soften for as long as the market remains free of major losses, even though the firm saw a 101.9% combined ratio for its P&C business in Q4 2016.

In reporting its fourth-quarter and full-year 2016 results this morning (coverage from our sister site), Munich Re revealed the extent of its major losses from the year and it transpires that the Q4 losses took the firms property & casualty reinsurance combined ratio over 100.

Munich Re also revealed that were it not for reserve releases, which are only available due to the way the company prudently reserves at its maximum estimates for each loss. In the fourth quarter the combined ratio could have been much higher without the benefit of reserve releases, as the reinsurance firm said the EUR400 million released could have added 5.7% to the already 101.9% combined ratio.

In such an environment, where major losses take you to a technically unprofitable position as in Q4, the fact that reinsurance pricing continues to show no sign of turning and that losses suffered in 2016 are no way near significant enough to force the softening trend to reverse, could perhaps be deemed concerning for traditional players.

Torsten Jeworrek, member of the Board of Management at Munich Re, explained the reinsurance market at January 1st renewals; “Market conditions for the renewals were once again challenging, even though the trend towards price reductions had continued to slow. So skilful cycle management is still extremely important, and Munich Re was once again able to react with flexibility in relation to changes. We withdrew from business that no longer met profit expectations – for instance, in China – and built up or expanded profitable business, either through new acquisitions or by strengthening existing client relationships.”

Cycle management has become increasingly important for companies like Munich Re, as they push capacity towards more profitable lines of business and into primary arms. The softness seen in global reinsurance markets has been spreading, into specialty and casualty lines, so these days places to hide are becoming fewer and harder to find.

Encouragingly though Munich Re found no change in demand for reinsurance at the January renewals, and at the same time did not feel that global capacity had changed significantly either, although changes in either could have helped to stimulate more pressure for a change in pricing.

At the January 1st reinsurance renewals Munich Re said that its rates fell by just 0.5% on average, which is half the rate reported a year earlier when pricing was down on its portfolio by 1%.

That would suggest more stability is ahead, but Munich Re believes that this softening is set to continue as well, forecasting more of the same for the rest of 2017.

“Munich Re is proceeding on the assumption that the market environment will not change significantly in the subsequent renewal rounds in 2017, unless extraordinary loss events occur,” the reinsurer forecast.

However the results that came out this morning showed that Munich Re still beat its profit target, despite all the challenges faced due to larger losses and lower pricing, reflecting the fact that reinsurance remains a profitable business.

Of course reserve releases played a big role, particularly in Q4 as without them the firm would have reported a lack of profitability in its P&C reinsurance, showing that reinsurers need to play a longer term game, of prudent reserves to help them out in future years.

Questions still remain on how long this trend can continue to help the company, especially as pricing continues to decline, albeit at a slower rate. Any dip in prudence, by under-reserving or over-releasing of reserves would show up very quickly in reinsurer results in the quarters and years to come.

Clearly an unprofitable P&C reinsurance quarter is not enough to stimulate any upward pressure on prices, according to Munich Re’s own expectations today.

So what’s the read-through for the insurance-linked securities (ILS) fund market and other collateralised reinsurance investments?

The importance of reserving adequately and establishing side-pockets has been clear for ILS funds in 2016, with the monthly loss events making this activity an increasingly important piece of the ILS business model.

Reinsurance pricing is set to continue to decline, so efficiency of capacity also remains important. But Munich Re showed that profitability remains in the business, even at the size, scale and expense base of one of the largest players in the world, which means ILS funds should easily be able to sustain the current pricing levels, although will likely continue their trend of selective underwriting and growth through new investor inflows that we’ve seen in the last year.

Finally, given the impact to Munich Re from catastrophes during the last year and particularly the fourth-quarter, it would be very interesting to know what impact was seen at the Eden Re collateralised reinsurance sidecar vehicle, as no doubt the investors there will have faced a share of the losses given that vehicles broad mandate.

Also this morning, fellow reinsurance giant Hannover Re reported an expectation that it will significantly beat its profit target for 2016. It will be interesting to see how large that firm’s losses were in the last quarter, as that may have impacted its sidecar strategy.