New reinsurance reality – Lower returns, underwriting focus: A.M. Best

The global reinsurance market may be heading for a new reality, where lower returns are the norm and an increasing focus needs to be placed on the contribution that underwriting makes to the bottom line, according to A.M. Best.

Everyone is looking for the answer to ‘where next’ for the global reinsurance market. Will it be a case of more of the same, a complete structural and business model evolution, or somewhere in between? A.M. Best believes the market is heading for a new reality, but how challenging that will be depends on how ready reinsurers are to adapt.

Despite the continued low level of global catastrophe loses and abundance of excess capital, which has helped to buoy reinsurance company results in recent years, the market does remain challenging for reinsurers and A.M. Best notes that returns for some are beginning to show “signs of stress.”

A new report from A.M. Best notes that the public reinsurance companies that it tracks have seen their stock price returns turn negative with the financial volatility in recent months, but the fact that they haven’t suffered major losses and that capital remains high has kept reinsurers looking more attractive investment opportunities than many other sectors.

Price declines continue across catastrophe lines, with an expectation of more to come albeit at a less rapid pace of decline than seen through late 2014 and early 2015. But reinsurers have been able to beat analysts consensus estimates due to low losses and continued reserve releases.

Conditions haven’t changed much, despite price declines slowing, and the reinsurance market remains one favoring buyers, with rates, terms and conditions all facing ongoing pressure and likely to impact companies’ results, A.M. Best notes.

Despite the price declines as well, reinsurers have been able to deliver reasonable results but A.M. Best feels that “this may not be sustainable for the long term.”

A.M. Best foresees a “new reality” for the reinsurance market. A reality where reinsurance becomes more of “an industry where returns are less impressive and underwriting will have to become a larger contributor to profits and returns.”

This, A.M. Best notes, will lead to reinsurers adopting an approach of “more conservative risk selection, more diversification of product offerings, a wider geographic reach and conservative loss picks.”

Reinsurance companies all seem to agree that 2015 will remain challenging and it is too early to tell whether 2016 will see more easy conditions for reinsurers, A.M. Best says.

Reinsurer management teams continue to focus on a disciplined approach to reinsurance underwriting, pulling back where necessary, which is resulting in a weighting of portfolios towards primary business, as pricing is relatively more attractive there and competition lower, resulting in easier access to business.

Looking ahead, A.M. Best notes that; “The expectation remains that reinsurance pricing overall will remain under pressure in 2015 given continued pressures from alternative capital and the lack of any price-changing event over the past few years.”

For 2016 the rating agency says that chances are pricing will remain under pressure, as capital levels remain high and competition from alternative capital and ILS fund managers is expected to continue. At the same time terms and conditions may continue to pressure reinsurer results as well.

“Third-party capital is expected to continue to enter the market as large pension funds and hedge funds search for ways to diversify their portfolios while chasing higher returns,” A.M. Best continues, adding that as a result “Given the current market environment, reinsurance and retro pricing is expected to remain under pressure going forward.”

Mergers and acquisitions (M&A) are expected to remain a feature of the reinsurance market too, with the pressure to diversify, achieve scale and consolidate competitive positions resulting in ongoing discussions between companies.

“Not everyone will win in the end,” A.M. Best warns.

There will be both winners, who manage to navigate the challenging environment, who choose well in M&A, or who find a complementary way to leverage alternative capital within their business model, and losers who fail to adapt.

“The solid players will be the ones that have been conservative in underwriting and in reserving, have been able to develop a book of business that will remain relevant for today’s market and that allows for quick shifts in and out of lines of business depending on market conditions, as well as companies that have created expertise in managing third-party capital to their own advantage,” A.M. Best explains.

Winners will be able to walk away from underpriced or unattractive business, A.M. Best continues, will have capital and expertise to expand into new lines, will be able to deliver the product selection and service level that global clients demand, will be able to participate in consolidation without being left on the sidelines and will be able to manage third-party capital to their own benefit, the rating agency continues.

“2016 will likely be another interesting year where we will see the industry continuing to evolve into something of a “new reality”,” A.M. Best says.

While it’s hard to predict what shape the reinsurance sector will take in years to come, as it evolves due to the structural influence of capital, competition and innovation.

When the dust finally settles, “the perception is that things will be very different than we have been used to over the past two decades.”

Reinsurers need to ready themselves for the new reality that is coming. If they haven’t already begun to adapt and prepare for it, it could already be too late.

Also read:

– Alternative capital and re/insurers’ can be best friends: Mike McGavick.

– Reinsurance market’s capital structure transformed: JLT Re.

– The reinsurance market – A new structural reality: A.M. Best.

– Alternative reinsurance capital signals structural pricing change: Morgan Stanley.

– More threat, more opportunities, more disruption: Re/insurance 2020.

– Reinsurance prices to stabilise, but at structurally lower levels: Goldman Sachs.

– M&A can help, but is it the answer to reinsurance structural change?.

– Soft market, new capital, structural change, the threats to reinsurers: Fitch.

– Structural change, lower margins, a deeper reinsurance convergence.