Reinsurance market sees lowest risk margins in a generation: Aon Benfield

The global reinsurance market is seeing the lowest risk margins in a generation, as traditional and alternative reinsurance capacity providers discover just how low their cost-of-capital will go, according to Aon Benfield’s latest renewal report.

As both traditional and non-traditional providers of reinsurance capacity find their risk appetite limits, in terms of the cost of their underwriting capital, it is presenting opportunities to cedents and stimulating new growth opportunities for insurers, says Aon Benfield.

The low-cost of reinsurance protection is also presenting growth opportunities to reinsurers, according to the report which will provide some solace to reinsurers feeling beaten down on price, as governments may be able to reduce their participation in catastrophe exposed regions as the availability and affordability of insurance and reinsurance improves.

Record levels of reinsurer capital and continued building interest from alternative capital investors have pushed the margins on reinsurance risks lower at June and July renewals, said Aon Benfield. The margins that can be earned on some reinsurance programs are now at their lowest levels for a generation, which shows just how soft this market is compared to some others seen in the last decade or two.

Private reinsurance capital is now able to compete at pricing levels once reserved for government backed reinsurance programs, as both traditional and alternative providers discover new low costs of capital. As an example, Aon Benfield cites the fact that some Florida hurricane placements at the renewals have been completed at costs of capital equivalent to the Florida Hurricane Catastrophe Fun protection, a real watershed pricing low.

The fact that private market reinsurance cover can compete with government subsidised schemes, surely demonstrates that these schemes are no longer required and the private reinsurance and insurance-linked securities markets are perfectly capable of absorbing many of these risks going forwards.

Reinsurance capital for the recent renewals grew to another high, according to Aon Benfield, with the broker recording $555 billion of reinsurance capital at the end of Q1 2014, an increase of 2.7% over the end of 2013 when reinsurance capital stood at $540 billion.

Growing reinsurer capital, up almost 3% in just the first quarter of 2014 - Source: Aon Benfield

At the same time that reinsurance capital has grown again, reinsurance demand continues to fail to keep pace, with demand relatively flat at the renewals according to Aon Benfield. Some cedents did chose to use the cost savings they made to increase their reinsurance purchase, but these were not sufficiently common to help soak up the excess capacity.

Traditional reinsurers responded to the continued competition from alternative capital and ILS, delivering meaningful additional value in terms of pricing and terms to cedents, according to Aon Benfield’s report.

The increased amount of reinsurance capacity in the market makes current reinsurance rate and pricing levels more durable, said Aon, suggesting that it will take at least a $100 billion loss event to cause a change in rate trajectory and to disrupt market pricing for any significant length of time.

Aon Benfield says that it is confident that current reinsurance rate levels will be sustained over time, given the high levels of capital deployed, more capital waiting to be put to work and the type of investors now looking to participate in reinsurance.

Both insurers and reinsurers are now in the process of incorporating this lower margin, or lower cost, risk capital into their planning and Aon Benfield expects these plans will accelerate as more seek to take advantage of the current pricing environment and the new-found generational risk margin lows.

This could result in some primary insurers returning to regions they had given up on, with new lower cost reinsurance capital able to support these ambitions. At the same time reinsurers are expected to continue to look to alternative capital to try to reduce their costs of capital, by incorporating it into their underwriting to leverage higher returns from lower margin business.

On terms and conditions, Aon Benfield saw more movement in traditional reinstatements, occurrence definitions, and terrorism language at the recent renewals. Aon Benfield puts this down to traditional markets desire to remain competitive, as do other brokers reporting on the renewals.

Alternative capital backed reinsurance capacity was up 4%, or by $2 billion in Q1 2014, according to Aon Benfield, which as we’ve said before is hardly reflective of the ‘yield hungry’ investors that the mainstream press seems to be so fixated on at the moment.

The Florida market saw increased demand, helped by both private insurers and Florida Citizens appetite for maximising reinsurance coverage in the currently attractively priced market. The private market increased its demand and bought reinsurance to higher return period levels, helping to at least soak up a little excess demand.

Aon Benfield’s report also looks at the catastrophe bond issuance in Q2 2014 and agrees with our view that the quarter saw the highest issuance of any quarter in the cat bond and ILS markets history. For more on the second-quarter catastrophe bond and ILS issuance download our Q2 2014 market report here.

Compounding the competitive, over-capitalised nature of the reinsurance market and likely to result in new low levels of risk margin and new lows in terms of cost of capital, are the continued low-level of catastrophe losses.

Aon Benfield’s report shows that catastrophe losses for the first-half of 2014 remain well below average. With the broker believing that a $100 billion industry loss event is required to turn pricing, a view held by many others, these figures provide no solace for reinsurers which may struggle to compete on margin to the degree that is now clearly necessary.

Insured catastrophe and weather losses by year and type, 2004 - 2014 - Source: Aon Benfield

So the news from Aon Benfield will not make easy reading for some reinsurers. The fact that cost of capital and ability to underwrite reinsurance business at the lowest margins in a generation is clearly key in the current market environment is likely to drive reinsurers to alternative capital in order to compete, or to further relax their renewal terms.

If these low risk margins are maintained it will give investors seeking to enter the reinsurance market a real opportunity to partner with reinsurers to do so. It will also provide ILS fund managers with extra ammunition to attract more investor capital, particularly if some traditional reinsurers begin to find maintaining these low risk margins difficult or damaging to their businesses and futures.

The market is set to stay interesting through the rest of this year and alternative capital and cost-of-capital look set to continue to be among the most talked about topics in reinsurance through the rest of 2014, as they have been for almost a year.

Further innovation in terms of business models and how alternative capital is brought into the reinsurer business also looks set to be a talking point, as reinsurers will be searching for ways to leverage lower cost capital to help them to stay competitive without taking on a damaging level of risk through further relaxation of terms.