With alternative capital one of the hottest topics at the Monte Carlo reinsurance Rendezvous over the last few days the subject of consolidation, mergers and acquisitions has been raised in many discussions and briefings.
One of the fears among some smaller reinsurers, particularly the property catastrophe focused reinsurance firms who compete most directly with alternative reinsurance capital, is that they will lose access to business and face increasing rate pressure.
This could lead to a desire to consolidate, merge or roll up smaller reinsurance entities into larger firms in the hope that a bigger market share and more capital to deploy helps them to survive the pressure from third-party capital in all its forms.
Rating agency Fitch Ratings said in a recent press release that it believes the reinsurance industry is facing an increase in mergers and acquisitions activity, as it comes to terms with higher valuations, the inflow of alternative reinsurance capital and the growth of new broker facilities such as passive underwriting and full-follow underwriting.
Fitch believes that consolidation will be good for the credit profile of many reinsurers, saying that it is possible that by reducing the number of reinsurers and the associated underwriting capacity it could help to lift prices or at the least slow their decline.
Reinsurers have looked like good candidates for consolidation in recent years anyway, according to Fitch, but the increase in alternative reinsurance capital, issuance of instruments such as catastrophe bonds, sidecars and industry loss warranties (ILW’s) could accelerate this trend. The growth of capacity and capital, increased competition, reduced pricing and reduction of growth opportunities are all going to increase the pressure on reinsurers who are in direct competition with the ILS and alternative capital providers.
At the same time Fitch says that passive underwriting facilities will also pressure smaller firms to merge. These facilities could put further pressure on pricing and lead to marginalisation among smaller firms and the heavily property catastrophe focused.
Fitch considers valuations of reinsurers as ripe for consolidation, with many valued near to or above book values. This makes mergers more likely and share repurchases less attractive, further stimulating the chance of a wave of consolidation.
Pricing is an issue though, said Fitch, if pricing continues to decline heavily at the January reinsurance renewals the prospects of merging might lose attraction. If you can’t profit from the business you’re targeting, and are facing competition which makes the business harder to access in some cases, growing your size is perhaps not going to help enough to make the merger process a viable option.
Of course, consolidation is not the only option for reinsurers as they seek ways to react to recent market trends. New business models and adjustments, or additions to, existing reinsurer business models is already happening and something the market is likely to see much more of.
As reinsurers become capital managers, deploying third-party capital with their underwriting, actuarial and modelling facilities becoming centres of excellence for capacity deployment, we could see new business models emerge. A number of property catastrophe reinsurers are already heading down this route and the changes in model, we believe, may become more dramatic.
Of course if the alternative capital trend continues apace, inflows increase and larger amounts of available reinsurance business head into the hands of institutional investors, even the major global reinsurers may not be immune anymore.
Consider the reinsurer with 10,000 employees and $50 billion in available capacity and how it competes with the ILS manager with 50 employees and $10 billion in available capacity. There is a disconnect here that logically suggests that a rationalisation of the large employee base is possible and under a scenario of increasing inflows perhaps even likely.
So it may not just be mergers and acquisitions, consolidation and a joining of forces among reinsurers. New business models will emerge and are already beginning to and the other possible result of all this change is a requirement to downsize and focus on becoming more lean and agile.
Interesting times are ahead for reinsurers, it is not all gloomy, there will be opportunities to profit to a greater degree for those who manage to adapt in the most appropriate ways. It’s going to be a trying time for some though, that cannot be avoided.
There is a very broad shade of grey between the possible outcomes for the global reinsurance market. This ranges from everyone becoming centres of underwriting excellence, servicing an increasingly large pool of alternative capital, to reinsurers becoming entities backed by increasingly diverse capital sources, to a blending of business models and increasing blurring of lines of distinction. The January renewals should give a better indication of where this will go and the next two to five years could reshape the global reinsurance industry in ways we as yet cannot predict.
There are so many reports and commentaries coming out on alternative reinsurance capital and ILS in the run up to and at the Monte Carlo Rendezvous event that we felt it worth highlighting some other reading on the topic, all from the last week or so, which you can find below (most recent first):
– Capital markets investors boost global reinsurer capital to $510 billion (including a useful list of links to many alternative reinsurance capital initiatives that we have covered previously)