Slowed entry of ILS unlikely to drive a turn in reinsurance pricing

It’s been suggested that the slowed entry of alternative capital and moderated reserve releases in the global reinsurance market might be stabilising the sector and lead to a flat January 2018 renewal, however recent market dynamics suggest we haven’t seen the end of rate declines.

Analysts at J.P. Morgan have suggested the reinsurance market cycle might start to turn in the second half of this year, citing Munich Re’s reduced profit guidance, the slowed entry of alternative reinsurance capital, and lower reserve releases when compared with more recent times.

The reinsurance giant recently issued a revised profit guidance for 2017 of €2 billion to €2.4 billion in response to the softening landscape, which J.P. Morgan says is “a clear signal by the group that it is now time for reinsurance prices to stop falling and start rising.”

“And Munich added that due to moderating risk appetite from alternative capital providers including pension funds and hedge funds, the excess capital level in the sector may be stabilizing and this could lead to a 0% renewal at Jan18, particularly as Munich said reserve releases are likely to moderate going forward as a source of profits for the sector as a whole.

“The one caveat is that in our experience, an actual recovery of pricing to positive figures has historically been associated with a large loss event: these events which were associated with a rise in prices include Hurricane Andrew in 1992, 9/11 in 2011, Hurricane Katrina in 2005 and the Tokyo quake in 2011,” said J.P. Morgan.

The rise of alternative reinsurance capital and its focus on catastrophe lines, alongside a relatively benign period for losses and the resulting excess traditional capital, has driven the sector to experience the steepest rate declines in a very competitive and challenging operating environment.

The entry of third-party capital has slowed in recent times in response to falling rates and even ILS funds have been feeling some of the pressures facing the traditional reinsurers, but is it wishful thinking to assume this is enough to stop reinsurance industry rate declines already?

As shown by the Artemis Deal Directory more than $2.4 billion of catastrophe bond issuance occurred in the first-quarter of 2017, the fourth consecutive first-quarter that issuance records have been broken, helping the outstanding market size end Q1 at a staggering $26.89 billion.

And this is at a time when cat bond prices have been coming down for the last four to five months or so, underlining the continued attraction to the insurance-linked securities (ILS) sector despite lower returns, as investors remain eager to invest in diversifying and uncorrelated insurance or reinsurance-linked business.

With cat bond pricing sustaining these new lows it suggests that collateralised reinsurance placements could follow suit at the upcoming renewals, although only time will tell if pricing in the collateralised markets will fall to the same levels seen in the cat bond space.

Traditional reinsurers’ appetites for lower pricing will also likely be tested at upcoming renewals, as it would seem almost assured that competition will ramp up again if cat bond pricing is any indicator.

If collateralised market capacity pricing is especially low at the upcoming mid-year reinsurance renewal season it could be that ILS investors have an opportunity to deploy more capacity, recent low cat bond pricing might suggest there are some advantages for ceding companies bringing in more capital market reinsurance backing at this time.

The April reinsurance renewal in Japan looks set to finish down further than had originally been forecast, with reports of -5% and greater declines on pricing, even as greater demand has also been seen. It will be interesting to see whether that has providing any opportunity for ILS funds and markets to deploy more capital.

Should prices continue to fall, what might control how far is the appetite of the traditional reinsurance market and its ability to continue to compete at pricing levels the ILS market is comfortable with. If the traditional reinsurers do fight back hard on pricing to offset competition and any shrinkage of their portfolios, it would herald further rate softening anyway.

With reinsurance rates at low levels already, but cat bond pricing continuing to plumb new depths it seems likely that a flat reinsurance renewal could be a bit further off than January 2018 at this stage.

Absent a truly market turning event, with industry experts and leaders seemingly unsure exactly what this might need to be in today’s overcapitalized and highly competitive marketplace, it’s likely that the softening landscape will persist through 2017 and into 2018.

A slowed entry of alternative capital, discipline shown by alternative and traditional markets, as well as more prudent reserving might well go some way to alleviating a little pressure in the sector.

But, based on what is being seen right now, we would expect further, albeit reduced pace rate declines in the coming months, as market conditions still suggest its too early for a complete turn in the market cycle and there are signs that the penetration of ILS and alternative capital into reinsurance is maintaining its recent pace and perhaps once again accelerating thanks to availability of risk.

Join Artemis in Singapore on July 13th 2017 for ILS Asia