“Mass migration” into specialty lines could amplify rate declines: KBW

The trend of insurers, reinsurers, and ILS players increasing their interest in specialty business lines will likely “intensify” rate declines, and could leave those that lack discipline and underwriting knowledge in a compromising position, warns Keefe, Bruyette & Woods (KBW).

In an effort to navigate the softening reinsurance landscape and avoid the most competitive business lines, such as property catastrophe, re/insurers and also insurance-linked securities (ILS) players have increased their efforts in other, potentially more attractive business lines.

While it makes sense to pullback on unprofitable business lines during a soft market cycle and look to deploy capacity elsewhere, in less competitive and ultimately more profitable classes of business, current market conditions and trends suggest this could drive down rates even further.

“We expect the industry’s “mass migration” into specialty insurance and reinsurance lines to intensify rate decreases, and eventually convey some reserve surprises for re/insurers for whom underwriting newer lines like Casualty isn’t a core competency,” said KBW.

Fitch Ratings also noted this recently, saying that “In 1H16, premium rates for London market insurers continued to fall, particularly for marine and energy and for property lines. Some insurers have attempted to mitigate this by diversifying into specialty lines, where rates have held up better, but we believe this could lead to price falls in these lines as well.”

Along with reinsurers increasing their focus on specialty insurance lines and increasing capital in those areas of re/insurance, the ILS market is starting to expand into specialty lines of reinsurance, and also directly into primary commercial property business.

Suggesting that any increased profits achieved by reinsurers outside of the more competitive lines of business could be short lived, as ILS capacity filters into new areas, ultimately increasing capitalisation and fueling competition.

Ultimately, ILS players, like insurers and reinsurers are attempting to navigate the softening landscape and are looking for better returns, increased diversification and trying to get closer to the original source of risk, all of which should increase efficiency in a market with thinning margins.

But it’s important that both the ILS sector and reinsurers resist underwriting business for the sake of underwriting, gain a solid understanding of the risks they are participating in, and practice disciplined reserving and underwriting.

“Reinsurers’ reserve release ratios decelerated to a still-favourable 8.6% of earned premiums, aligning with persistent soft reinsurance pricing that typically translates into lower future reserve releases,” said KBW, in a recent report that recaps P&C insurance earnings during the second-quarter of 2016.

Although catastrophe losses increased during the first-half of 2016, generally, losses have been benign in recent times. A lack of large loss activity, low interest rates impacting the investment side of the balance sheet and the overall reduced profitability of the re/insurance sector, has seen some companies practice aggressive reserve releases to mask true underwriting gains and mitigate lower yields.

With reserves running thin and returns remaining low, there’s a real chance that re/insurers, and ILS players that enter new business lines in which they perhaps lack experience and underwriting prowess, could experience some “reserve surprises.”

It’s been reported throughout the softening market cycle that some re/insurers have lacked discipline with regards to underwriting, reserving and terms & conditions (T&C), in an effort to gain an edge on the expanding base of competition from both the traditional and alternative market participants.

This certainly isn’t the case for everyone, though, as reinsurers have also been seen to walk away from unattractively priced business and resisting any dangerous loosening of T&Cs at renewals.

At the same time, industry observers and experts have highlighted the discipline of the ILS space in more recent times as all aspects of the sector show a willingness to increase their understanding of the underlying exposures, and have also been seen to turn down business that is simply priced too low.

The softening landscape shows little sign of waning anytime soon, and absent a truly significant loss event, or an aggregation of medium sized events resulting in the removal of a substantial amount of capital from the sector (although some believe the volume of capital waiting to enter the space will limit any post-event price surge), discipline is going to remain essential in surviving the turmoil.

For ILS players looking to enter new business lines, it’s important to hire experienced underwriters that understand the risks, and the same goes for insurers and reinsurers.

When a major event does occur and the market begins to turn it’s likely that some companies will find themselves in extremely difficult positions, ultimately paying for ill disciplined underwriting and reserving during the softening market cycle.

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