Mergers & acquisitions in the reinsurance market are set to continue, according to a new report from Fitch Ratings on the reinsurance market. But scale, while sure to help some under-pressure reinsurers, may not always be the answer to the real issues causing structural change.
Fitch’s report hits on some of the issues that reinsurers are finding it difficult to respond to; the increasing amount of alternative capital or direct capital markets participation in reinsurance, alongside the changing reinsurance purchasing and distribution landscape.
Fitch discusses the fact that the January renewals, which saw prices decline broadly across reinsurance lines, herald a continued decline in pricing across the remaining renewals of 2015. The expectation is that prices will continue to see year-on-year declines in April, June and July, ramping up the already palpable pressure.
“Small may no longer be perfect formed for the shape of the future reinsurance market,” Fitch explains, adding that the M&A deals seen so far all appear to be about acquiring diversification or scale.
Should the current soft market cycle be protracted, Fitch notes, reinsurers with less diversity within their books and lacking the scale to compete for positions on programmes may find themselves increasingly marginalised.
The rating agency also notes that those without the required scale may find it harder to turn down unprofitable business, as they need to sign onto programmes not matter the terms in order to maintain premiums coming in.
Some trends are supporting the trend towards scale; global brokers driving the distribution of risk, large insurers centralising purchasing and higher costs driven by regulatory requirements, are all factors that favour the larger reinsurer, Fitch explains.
And Fitch supports the view that scale matters, saying that “scale and diversification are attributes that are likely to improve reinsurers’ longer-term fortunes in the future sector landscape.”
However, M&A for scale and diversification’s sake is not advised, and Fitch says could be viewed negatively if it’s not apparent that the larger entity would improve its market position without compromising profitability.
But the key takeaway is that despite the low loss environment boosting capital in the sector and ramping up competition, other factors are also driving structural change. Alternative capital’s growth in reinsurance is one, clearly the growing appetite of the capital market’s to directly access insurance risk is disrupting the space. Others are the changing purchasing of reinsurance and new ways of distributing risk capital. All of these are “significant factors in reducing prices,” Fitch says.
While M&A may reduce some capital in the space, it will not change the structural trends that are making reinsurance a more competitive place to operate, unless of course you have lower-cost capital and an innovative approach to acquiring and underwriting risks.
And here’s the real question for reinsurers right now. M&A may give you scale and diversity, which can help you navigate the challenging market more successfully right now. But, is it going to give you the edge that sets you up to outperform in the coming five, ten or twenty years, as reinsurance and risk transfer settles into a new and structurally different market environment?
Because surely that’s what’s coming. While some feel we have seen ‘the change’ already and now everyone can adapt and settle into a new status-quo, there are plenty more in reinsurance, the capital markets and looking in with interest from the outside, who feel that this is only the beginning.
It remains a certainty that large, globally diversified reinsurers, particularly those with primary units, will continue to lead the reinsurance market. But who will lead the rest of the panels on major reinsurance programmes in future? Will it be mid-sized diverse reinsurers, or specialist, low-cost capital providers, like the increasingly sophisticated ILS fund managers of the world?
Of course it’s hard to say at this time. But as pricing continues to remain under pressure, two things remain vital. Cost-of-capital and an ability to wield that capital efficiently, as well as innovation in product design and how you deploy them.
So scale is certainly not everything, but we are still likely to see much more M&A before we really begin to understand the future landscape of the reinsurance market.
Fitch says that while the reinsurance market’s loss experience remains low it expects; “Further price softening for 2015 renewals. The higher weighting of non-proportional catastrophe business that is re-priced in April, June and July raises the possibility of steeper price declines than for January’s renewals.”
And perhaps reflecting why reinsurance remains so attractive to outside capital and also to innovators with new business models Fitch explains; “Despite the challenging outlook, we expect pricing at the portfolio level to remain adequate for most traditional reinsurers throughout 2015.”
If pricing is adequate for traditional reinsurers, how adequate is it for those with lower-cost business models and capital? Potentially very.
While that remains the case, even those reinsurers with scale should expect to remain under pressure. For while the market remains profitable and attractive to capital, there will always be those who find interesting ways to introduce and match it to risks.
Perhaps that favours the large, diverse reinsurers that also embrace the capital markets (out of the traditional bunch)? Time will tell.