Financial services and investment banking firm Credit Suisse has published a report on the reinsurance market which discusses the impact of insurance-linked securities. The report concludes there is; “No reason to believe the growth trajectory of insurance-linked-securities reinsurance structures and the subsequent pressure it puts on pricing will dissipate for the foreseeable future.”
Credit Suisse sent its investment researchers and analysts to Bermuda recently, to speak with nine reinsurance companies and to assess the state of the reinsurance market and the growing insurance-linked securities sector. These research trips are relatively common, however it is telling that the two most recent analyst trips (our article on Morgan Stanley’s recent trip) have resulted in considerable discussion of the impact of third-party capital on reinsurance pricing.
The report says that Credit Suisse believe that reinsurance pricing at the June 1st mid-year renewals for Florida risks will be down 10% to 15%. They expect the price declines to be less negative later in 2013, as the insurance-linked securities sector has less impact on non-U.S., non-Florida regions, but still expect reinsurance price declines in the range of 5% to 10%. Outside of a $25 billion dollar catastrophic loss event, Credit Suisse sees no reason for overall property-catastrophe reinsurance rates to stabilize in 2014 either.
As a result of these reinsurance rate forecasts Credit Suisse is reducing its EPS (earnings per share) estimates for many large reinsurers, with the average downward adjustment being 5%. This negative sentiment is not a suggestion that any reinsurers are in trouble, rather that the lower rate environment and pressure on reinsurance pricing caused by ILS and third-party capital are here to stay.
Even if a large reinsurance loss event does occur, Credit Suisse is not confident that reinsurers will bounce back as quickly as they have in the past, the ample excess capital positions of global reinsurers being one reason for this. The report cites ILS providers access to ample capital, which can be deployed more quickly than a new breed of start-up reinsurers could manage, as another reason for this. Nephila Capital and its recently forged relationship with KKR & Co. L.P. (or Kohlberg Kravis Roberts) is a prime example of the ILS sectors access to ample capital and could see losses replaced with new capacity very rapidly if a rate opportunity presents itself.
Berkshire Hathaway is cited as another reason that reinsurers may not bounce so high after a major loss event, perhaps suggesting that Credit Suisse believes that Warren Buffett’s reinsurer may decide to move more firmly into the U.S. property catastrophe market if an opportunity to profit presented itself. Were Berkshire Hathaway to launch itself firmly into the U.S. property catastrophe reinsurance market the reinsurance market could be stirred up even more.
Interestingly, Credit Suisse believes that reinsurers may be creating some of the downward pressure on reinsurance rates themselves. The report’s author, analyst Michael Zaremski, says that Credit Suiss has concluded that some of the downward pressure on property-catastrophe reinsurance rates has been self-inflicted by the wave of start-up ILS platform launches from traditional reinsurers. Zaremski attributes these start-ups as causing perhaps as much as 50% of the pressure on reinsurance pricing.
Here reinsurers find themselves in a bit of a no-win situation. Feeling forced to embrace third-party capital and the ILS reinsurance model, large reinsurers may have added to the over-capitalisation of the sector and themselves encouraged more capital into the space which has the ability to underwrite risk for a lower return.
It could be viewed such that reinsurers have created their own pool of lower-cost capital which can compete directly with their other higher-cost pools of capital. There will be a learning process here where reinsurers have to establish the best way to manage third-party capital, where to deploy it and how to minimise the impact it has across all rate areas. However the impact of ILS and third-party capital is something that reinsurers need to get used to and it is the innovative, fast-moving companies who will likely cope best here.
The pressure created by third-party capital and ILS platform launches will lessen over time, according to the report, but is unlikely to let up over the next year the analysts believe. Credit Suisse cites the currently small size of reinsurers ILS platforms relative to re/insurers desires to grow their ILS platforms as one reason for this. The report also cites the fact that there are other ILS platforms which will likely launch for the January 2014 reinsurance renewals, mentioning XL Group, Aspen and Lancashire as third-party capital managers set to aim for this important point in the reinsurance calendar.
Credit Suisse says that it is still struggling to understand how much of an impact ILS could have on other areas of the reinsurance market. Some ILS platform managers have expressed a desire to move into non-catastrophe lines of business, such as Lancashire who discussed adding non-property catastrophe shorter-tail risks within its third-party capital reinsurance vehicle.
Credit Suisse then discuss reinsurers stock prices and says that it believes that a majority of the near-term negative news, including the discussion of pricing pressures, has been largely priced in to reinsurers share prices. For some reinsurers, their broad focus on lines of business outside catastrophe risks helps, for others their ILS and third-party capital management platforms are expected to eventually offset some pricing pressures.
The report closes discussing RenaissanceRe, a reinsurer who it says has a more pronounced exposure to property-catastrophe pricing and rate pressures. Credit Suisse says that RenRe has shown an apparent unwillingness to expand its third-party capital platform to underwrite new Florida (not existing) reinsurance demand. The analysts report closes by saying that this new Florida reinsurance demand has, for the most part, gone to insurance-linked securities platforms, such as Nephila.
The report from Credit Suisse gives a great view of the state of the reinsurance market as it grapples with the ‘new normal‘ of ‘fast capital‘, increasing convergence of the reinsurance and capital markets and ILS market growth helped by continuing inflows of new capital.
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