M&A won’t stop the tide of reinsurance price declines: S&P

Rating agency Standard & Poor’s gave an update on how it views global reinsurance sector trends at an event in London recently, highlighting the continued growth of capital, ongoing price pressure and saying that M&A won’t reverse these trends.

Dennis Sugrue, Director and Sector Specialist for Reinsurance at S&P, explained that the rating agency still sees negative credit trends in the reinsurance market, largely created by continued pressure on supply and demand.

“We’re still seeing record levels of capital in the market. Alternative capital continues to flow into the market quite freely as well. At the same time we’re seeing a change in demand dynamics,” commented Sugrue.

S&P has repeatedly highlighted the changing demand side dynamic as large buyers of reinsurance have rationalised and centralised their approach to buying risk transfer. Now, Sugrue said, this trend is moving on to smaller players who are also rationalising their reinsurance programs.

“Last year we were talking about a lot of the large global cedents who were changing the way they were buying reinsurance. We’re continuing to see that with some of the big global multi-liners, but even some of the smaller reinsurance buyers are starting to take a more centralised approach, so this is starting to spread down the ranks,” he explained.

S&P still expects smaller, less diversified reinsurance players will struggle, as they try to defend their competitive positions. But profitability is going to be an issue for many in the space, even among the larger players, although the most diverse and globally active re/insurers will weather this better than others.

Continued softening of prices in reinsurance lines is expected to pressure the sectors capital and earnings.

Sugrue said; “We forecast that reinsurers will have trouble meeting their profitability targets this year and next year, in many cases returns on equity and returns on capital will barely meet the costs of equity and costs of capital for the sector. I think this leads to many looking for other options.”

“Reinsurers will have to continue to focus more on underwriting,” Sugrue explained, adding that S&P does not expect reserve releases to completely disappear but it does expect them to decrease further and does not view them as sustainable.

Investment returns which had been high-quality and liquid are now at a point where S&P sees them inhibiting earnings and it expects investment returns to remain difficult in a low-yield environment for some years to come.

Again, this puts the focus onto underwriting for profits, but with pricing down, competition higher, alternative capital and insurance-linked securities (ILS) eating into the pie and buying rationalised, this is a tough ask for reinsurers right now.

Shareholder equity continues to grow and as a result S&P expects the market to remain awash with capacity for the foreseeable future.

Discussing the growth of alternative capital, Sugrue said; “Alternative capital is reaching record levels. We expect that 2015 will see similar levels of cat bond issuance (to 2014). There’s been a target out there, or an estimate, that roughly $8 billion of cat bonds will be issued in 2015, we don’t think that’s impossible based on the deal-flow that we’ve seen.”

Sugrue said that a lot of the alternative capital is putting pressure on property catastrophe rates, in addition to all the traditional capital in the market. This is forcing traditional reinsurers to look elsewhere, creating a spill-over effect as rate pressure expands to other lines of business as well.

As a result of the ongoing trends in global reinsurance S&P expects profitability to be deteriorated. Sugrue said that is already being seen and that this is expected to persist as rate pressure continues, investment returns remain depressed and reserve releases slow down.

S&P now forecasts an average return on equity RoE or 7% to 9% for 2015 and 2016, while combined ratios are likely to be 97% to 102% in 2015 and 99% to 104% in 2016.

Consolidation remains at the top of reinsurers agenda’s Sugrue said, with price to book values perhaps being more accommodating of M&A activity right now. S&P said that it expects to see a few more deals “come down the pipe” in the future, but it sees the majority of these deals as defensive in nature to date.

“We don’t think that these combinations are really going to affect the amount of capital in the industry,” Sugrue said “and won’t stop the tide in terms of reinsurance pricing.”

The deals to date are not really pulling significant capital out of the market and so capacity will likely remain high, while fewer larger reinsurers could mean fiercer competition between those that are left.

The main messages from S&P remain the same. An expectation that more than half of the global reinsurers it rates are more exposed to competitive and earnings pressure, but that others with the necessary scale, diversity and scope should be able to withstand it.

For smaller, more concentrated reinsurance firms, there is a need to carve out a competitive position, while also protecting capital and bottom line. This could mean an M&A deal ahead for many in this group.

Finally, those who cannot adjust to the ongoing turbulence in the reinsurance market will struggle to survive. S&P’s negative reinsurance sector outlook continues as a result.