Alternative capital grows share at reinsurance renewals: Guy Carpenter

Alternative reinsurance capital grew its share at the January reinsurance renewals, in a market characterised by further falls in reinsurance pricing and even broader terms and conditions, as recent trends continued, broker Guy Carpenter says.

The January 1st 2015 reinsurance renewals have yet to be described as a bloodbath by any media (that we’ve seen) but the general consensus is that reinsurers suffered more of the same. Lower pricing was witnessed across many market segments, impacting almost all lines of business and geographies, Guy Carpenter explains, as the trends seen in recent renewal seasons continued.

The Guy Carpenter Global Property Catastrophe Reinsurance Rate-on-Line (ROL) Index, a broad measure of pricing adequacy across catastrophe risks, was down by 11% at the renewals this year. In fact, looking at our article discussing Guy Carpenters renewal comments from back in January 2014, the fall is the same as a year earlier suggesting that in the cat market at least the impact on reinsurers has been just as bad in 2015.

A major factor driving the rate trajectory of property catastrophe reinsurance risks was a continued lack of costly catastrophes in 2014, Guy Carpenter says. The broker estimates total catastrophe losses at around $30 billion in 2014, the lowest total in four years and 25% lower than in 2013.

The continued entry of alternative or third-party sourced reinsurance and insurance-linked securities capacity from the capital markets is, of course, another major reason for continued downward pressure on rates. Institutional investors such as pension funds continue to appreciate investments in catastrophe risk and other reinsurance classes and as a result the amount of third-party capital in the market has continued to grow.

Guy Carpenter estimates that convergence capital has expanded to further grow its share of the market, with its use in catastrophe risks growing to 18% of catastrophe reinsurance capacity during 2014 at $60 billion, up from 15% at the end of 2013.

A positive factor of this growing pool of lower-cost reinsurance capital is the ability for buyers to secure greater cover at lower cost and Guy Carpenter acknowledges this, saying that growing convergence capital was; “A contributing factor to the moderate expansion of overall catastrophe limit purchased as pricing came down and buyers were able to secure more limit at lesser cost.”

Alternative capital continues to grow and access reinsurance in a variety of forms, but Guy Carpenter notes a lower amount of industry loss warranties (ILW’s) in 2014, as lower priced indemnity protection became more attractive thanks to lower-cost capital availability. Growth in collateralized reinsurance, sidecars and of course catastrophe bonds more than offset that shrinking of the ILW market.

We should note that ILW’s remain a popular form of risk transfer and market sources suggest that ILW’s bound at the January 1 renewals may be up on a year earlier, as buyers found the pricing so attractive this year.

The result of lower levels of catastrophe losses, with the resulting excess capital at traditional reinsurers, alongside increasing amounts of alternative capital, has been surplus capacity in most lines of business, Guy Carpenter says. With surplus available prices go down and also terms and conditions can be pushed as buyers look for more value from highly competitive traditional and alternative markets.

“Market conditions that continue to bring downward pressure on pricing are being met with tremendous, client-focused innovation,” commented Lara Mowery, Global Head of Property Specialty at Guy Carpenter. “The result has been a customized approach with expanded product offerings and terms and conditions that benefit our clients.”

The expansion of terms and conditions is considered by many to be a dangerous game, with unrelated risks being bundled into catastrophe treaties, longer hours clauses and other broadening of terms, potentially resulting in greater risk being assumed by reinsurers for much lower reward. The benefit to brokers clients, however, cannot be denied.

Reductions in pricing also occurred in most other lines of business, Guy Carpenter continues, as reinsurers looked to put excess capacity to work. This had the result of increasing competition across all lines. The concern here is that this expansion of reach by reinsurers looking to deploy capital could result in expansion of terms on lines of business that are not a core competency for the businesses, something to watch in the future.

Overall capital kept growing, with Guy Carpenter estimating that dedicated reinsurance sector capital was at a near record level, at approximately USD400 billion at year-end 2014 from traditional rated markets and all sources of alternative capital including sidecars, collateralized reinsurance vehicles and catastrophe bonds.

“The sustained influx of capital from new entrants and growth from traditional sources continues to reshape the reinsurance landscape’s capital structure and drive innovation in the form of insurance-linked securities (ILS) and collateralized aggregate solutions,” David Priebe, Vice Chairman of Guy Carpenter, said.

Traditional reinsurance companies continue to look to the capital markets for new business models, partnerships and M&A, which Priebe explains is resulting in a continued, or perhaps deeper, reinsurance convergence.

“We are also seeing reinsurers execute strategic decisions through the utilization of third party capital facilities and M&A activity in response to new market realities; which is further blurring the lines between ‘alternative’ and ‘traditional’ markets,” Priebe said.

While some are expanding buying, increasing their coverage, improving their protection for the same or a decreased spend, a counter trend sees continued centralisation of reinsurance buying resulting in greater retentions by large insurance groups and more focused reinsurance spend with a smaller panel of markets.

“However, the lower rates, broader terms and conditions, and excess capacity available across the EMEA region have meant that creative opportunities can still be found for a wide range of clients,” commented Nick Frankland, CEO of EMEA Operations at Guy Carpenter.

In the new and evolving reinsurance market environment, “Companies are being challenged to rethink their overall capital management,” Guy Carpenter says. Insurers are looking to reduce their cost of capital, due to lower underwriting returns, as well as looking for higher returns on their assets to replace lost underwriting income. The same can be said of some traditional reinsurers.

Expense management and synergies, along with greater scale and diversification are being sought by many in the traditional markets, as efforts to maintain profitability continues apace. Clients have also been pursuing coverage and pricing goals using a tailored mix of traditional and alternative capacity, Guy Carpenter says, which also reflects the more permanent role that alternative capital and ILS are now playing in cedents reinsurance programs.

Guy Carpenter says that at the renewals its clients were most commonly seeking extended hours clauses, improved reinstatement terms, the inclusion of non-modeled lines and expanded coverage for terror exposures.

Looking ahead, Guy Carpenter expects clients will increase demand for state-of-the-art and customised or tailored solutions, with a definite increasing importance of capital agnosticism. The broker expects clients will increasingly seek help with structuring of alternative reinsurance capital vehicles, entering new market and the creation of new distribution channels and new products to address emerging risks.

The excess capital issue is set to continue, Guy Carpenter believes, with no let up in alternative capital and ILS investor interest in reinsurance and catastrophe risks, while low investment returns continue and without major catastrophe losses the challenging environment is expected to persist into 2015.

So no surprises in the latest reinsurance broker commentary on the January renewals. Guy Carpenter’s commentary reflects that of the other brokers, that capital and competition continue to weigh heavy on the reinsurance market, resulting in buyers conditions for cedents and challenges for reinsurance markets.

Third-party capital continues to grow and increase its profile and importance in cedents reinsurance programs and this trend is expected to continue.

With no respite expected the outlook for the rest of 2015 remains one of continued challenges, but with an increasing focus on innovation, product development or leveraging alternative capital providing some potential bright spots for reinsurers that could see some companies outperform.

Read all our coverage of the January reinsurance renewals here.