Reinsurance rate softening, broadening of terms ahead in 2015: KBW

Analysts at Keefe, Bruyette and Woods expect continued rate decreases across reinsurance lines through 2015, with softening most pronounced in property catastrophe risks, while at the same time further broadening of terms and conditions is expected.

The prospects for the reinsurance sector in 2015 continue to look gloomy, with every analyst report or opinion suggesting that while the market remains so well capitalised and free of large catastrophe losses, while alternative or ILS capital continues to increase in volume, there is no sign of the downward spiral in rates and expansion of terms reversing.

Keefe, Bruyette and Woods (KBW) insurance and reinsurance equity analysts published their 2015 outlook for property and casualty insurance and reinsurance this week and expect rate decreases to continue, while any rate increases are expected to slow in trajectory.

This outlooks goes for the majority of primary and reinsurance lines and the two will likely have a knock on effect on each other, as reinsurers look to primary business to recoup rate lost from their traditional underwriting lines.

At an industry level, KBW analysts expect an environment of steady economic growth domestically in the U.S., persistent competition on prices in insurance and reinsurance, modestly positive loss cost trends, a switch towards more normalised catastrophe losses and continued low interest rates.

Most lines across both P&C insurance and reinsurance are either decreasing modestly or increasing at a slowing pace, the analysts explain. This general slowdown is expected to continue across P&C insurance and reinsurance rates through both 2015 and 2016, but with property catastrophe reinsurance clearly once again the line of business likely to see the sharpest declines.

For property catastrophe reinsurance the KBW analysts forecast double-digit rate decreases at the January 1 2015 renewals, as rates catch up to the declines seen at mid-year 2014. Beyond that catastrophe reinsurance rates are expected to continue to soften, but at a slower rate with low to mid-single digit declines expected for the middle of 2015 as well.

Scenarios that could disrupt this forecast include a resurgence of claim cost inflation, that eroded current and prior year profitability and might stimulate rate increases. On the other hand the analysts note that should third-party capital continue to push into insurance and reinsurance lines and seek to expand beyond short-tailed business, such as catastrophe risks, this could change the outlook.

The analysts do not believe an expansion in the remit of third-party capital is imminent, because longer-tailed lines would tie up capital for longer and expected turns are not as attractive here as property catastrophe was two years prior, but as the traditional re/insurers are reasonably disciplined to avoid destructive pricing it would likely take a rapid expansion of ILS and third-party capital to really push the needle down across broader areas of the market.

KBW notes that, particularly in commercial and specialty lines, on a normalised basis there is a good chance that reinsurers and third-party capital can continue to underwrite catastrophe risks at a lower return on equity than rate forecasts imply, which suggests that there is additional room for rates to decline in real-terms.

Specifically for reinsurance, the significant levels of excess capital still in the market and the continued benign level of catastrophe losses in recent years probably imply another year of 5% to 10% rate decreases, according to KBW, which on top of the declines seen in 2013 and 2014 mean rates are significantly lower than in previous years, extending this buyers market.

The analysts also expect further broadening of terms and conditions (such as the hours clause extension) and more inclusion of other risks such as cyber and terrorism. Both of these are considered to be more dangerous to reinsurers than rate declines alone, according to the report.

KBW sees the efforts of some reinsurers to expand into casualty risks, citing RenaissanceRe’s acquisition of Platinum Underwriters and Validus Holdings acquisition of Western World, as evidence that there is an expectation that conditions are going to remain testing and softening prolonged in property catastrophe risks. However these casualty rates are facing modest pressure now as traditional capacity is diverted away from catastrophe risks.

For brokers, the decline in rate is expected to have a knock on effect on organic growth rates. While brokers are pushing more resource into becoming capital market brokers, adverse trends in reinsurance, such as pricing and demand sliding, are likely to only be modestly offset by brokers efforts to place insurance-linked securities (ILS) or their work in M&A, said KBW.

In terms of the prospect for mergers and acquisitions in 2015, KBW says that as the traditional reinsurance business model continues to evolve, a diverse platform is likely to weather the soft market better than a narrowly focused one. As a result it is the concentrated reinsurance carriers are the ones most likely to be forced to sell. Buyers are likely to be attracted to profitable specialty players which have a demonstrated advantage in niche, lower competition markets.

So another gloomy outlook sets the tone for 2015 as one of continued softening, some further expansion of terms and coverage and more pressure for the most affected insurance and reinsurance players. Expect more similar commentary as we approach year-end and the outlook may become even clearer once the outcome of the January renewals are understood.

Further reading:

– Select group of reinsurers have necessary scale, diversity, strength: Fitch.

– What happens when the music stops (reserve releases run dry)?

– Some re/insurers rely on investment returns to make a profit: PwC.

– Reinsurer returns near cost-of-capital, ILS to win more market share: Moody’s.

– Renewal rates to drop as alternative capital drives secular change: Analyst.

– Consolidation may be a natural outcome for reinsurers: EY.

– Insurance and reinsurance mergers and acquisitions to increase: Fitch.