Reinsurance evolution ongoing. Capital market’s role key: A.M. Best

The evolution of global reinsurance continues with the capital markets and insurance-linked securities (ILS) playing an increasingly important role as large, resulting in a clear need for players to form larger, globally diversified re/insurers and leverage alternative capital, according to A.M. Best.

The global reinsurance market remains challenged and these market forces are expected to continue to shape the reinsurance landscape over the coming years, as the evolution of the reinsurance business model continues.

The purely traditional reinsurer business model is no longer working for many companies, resulting in a renewed search for scale, diversification and partners that can shelter smaller players from ongoing headwinds.

This is despite the major losses of 2017 and the higher rates achieved at the January 2018 renewals, which are now seen as likely insufficient to improve the fortunes of the reinsurance market on their own and without further impacts to the market’s well-capitalised base.

A.M. Best highlights the recent announcement of the acquisition of Validus by insurance giant AIG as, “The latest chapter in the evolution of the traditional reinsurance model, where specialty focused businesses seek shelter as part of a significantly larger globally diversified enterprise.”

While some market participants have cited the improvement in reinsurance rates at 1/1 as “an indicator of an improving market climate,” A.M. Best notes that, “Any long-term optimism seems foolhardy given the level and fluidity of reinsurance capacity available to respond to any opportunity.”

The adaptation of the traditional reinsurance business model continues apace as a result, with A.M. Best saying that reinsurers continue to adapt into a new role as “gatekeepers of insurance risk.”

The rating agency has said this before, saying that reinsurers should evolve to become the gatekeepers of risk and agnostic providers of capital (agnostic as to source).

But following the losses of 2017 and the realisation that reinsurance rates would not bounce as high as the market would have liked, the urgency to embrace a new business model, where technology, portfolio management, and capital allocation combine to help reinsurers make their own balance-sheets more effective and reduce their own cost-of-capital.

The trend for reinsurers to look to manage and share risks with third-party providers of capital, for both property and non-property lines of business, is expected to continue, A.M. Best notes.

“There is a clear sense of the need to form larger, global, well-diversified operations with broad underwriting capabilities to assess risk and to serve as transformers of risk to the capital markets,” the rating agency says.

The AIG / Validus combination is “a case in point of this inevitability” the rating agency continues.

While insurers and reinsurers want to position themselves as the best placed players to effectively match risks with all types of capital, not every company will be capable or attractive for third-party investors to work with, meaning the landscape of companies is likely to shrink.

“As market players look to become more efficient, either through disintermediation or going directly to sources of risk, this tug of war will result in fewer hands in the pot,” A.M. Best forecasts.

Ultimately, this is going to benefit the buyers of insurance and reinsurance protection, with heightened efficiency of products and the capital backing them. But this won’t benefit everyone.

Legacy players may find themselves unloved by alternative capital investors, unable to provide sufficiently broad portfolios of risk for ILS players to back, and therefore increasingly marginalised, while at the same time their own capacity starts to look increasingly uncompetitive.

Some franchises in existence today may not survive, A.M. Best suggests, as competition and earnings pressure result in ongoing consolidation, as making acceptable returns becomes increasingly difficult for some traditional players.