Reinsurance price pressure to persist, ROE’s to struggle: A.M. Best

Pressure on reinsurance and retrocession pricing is likely to persist through the rest of 2015 and beyond, as alternative capital continues to expand within the market and market-moving loss events remain absent, according to A.M. Best.

In its latest report on the global reinsurance sector A.M. Best hasn’t changed its outlook for the space, expecting pressures to continue, prices to remain pressured, terms and conditions to continue expanding and ultimately reinsurer returns on equity (ROE) to suffer.

Reinsurers have been assisted by the low level of losses, positive prior year reserve releases and the high levels of capital they have managed to accumulate as a result. This has enabled them to outperform stock markets in 2014, with share prices increasing higher than most industries, but that performance will be hard to sustain.

The pricing pressure that was evident throughout 2014 has continued into 2015, with further reinsurance rate declines, especially for catastrophe exposed lines, at the January and April renewals. The expectation is that there will be further declines, although perhaps less steep, at June and July renewals.

As alternative capital from insurance-linked securities (ILS) investors such as pension funds, sovereign wealth entities and family offices continues to enter the reinsurance space, and asset managers such as hedge funds continue to target establishing start-ups, the pressure shows no sign of letting up for traditional reinsurance firms.

“Given the current market environment, reinsurance and retro pricings are expected to remain under pressure going forward. The current reinsurance market remains a ‘buyers’ market and rates, terms and conditions continue to be under pressure impacting company results,” A.M. Best explains.

A.M. Best focuses on the fact that reinsurers have been able to produce consistent results, despite the reductions in pricing and expansion of terms and conditions. Those two factors effectively mean that reinsurers have been taking on more risk, for lower return, with broader terms and also from centralised buying.

The upshot of that could be greater concentration of risks, greater uncertainty when it comes to losses, which means that surprises could emerge for some reinsurers, or indeed ILS players, when either large or an aggregated number of loss events occur.

Large reinsurers are adjusting their books as a response to market conditions, with more of a focus on casualty, specialty and also on primary insurance business. In fact A.M. Best sees reinsurer portfolios becoming increasingly weighted to primary business, as “pricing continues to be relatively more attractive and access to the business easier than on the reinsurance side.”

However the window of opportunity in primary property exposures may be narrowing now, with A.M. Best saying that reinsurers indicated that; “Property pricing pressures and competition is becoming more pronounced on the primary side as well and that it is becoming more challenging to find good profitable business.”

Reinsurance companies agreed that 2015 will remain challenging and that it will lead to “an even more careful approach to risk selection.” At the same time companies said that they expect the current M&A activity will continue throughout the year and beyond, as the fight to remain relevant continues.

“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,” according to A.M. Best.

“The intensified competition in property reinsurance and CAT continues to spill over to other lines of reinsurance as companies attempt to expand their product offerings and global presence. This, in turn, continues to put upward pressure on ceding commissions on quota share placements and leading to more multiyear contracts, broader contract terms and increased signings on aggregate covers. These conditions are likely to remain throughout the year absent any major event,” the rating agency continued.

If capital continues to enter the market, reserve releases decline, pricing continues to soften and cedents continue to retain increasing amounts of business, returns for reinsurers are expected to get increasingly hard to maintain.

We’d say that is a given right now. Capital is finding an increasing number of vehicles available to it and different business models and strategies are now encouraging third-party investors to back them. Reserve releases have been expected to slow for some time now, so without major losses to help rebuild them that boost to earnings will certainly drop. Prices look set to at the least remain at the low levels where they are seen today, without any major loss events. Finally, as companies launch initiatives that help them to extract more of the premium out of the risk they underwrite (such as ABR Re), greater retention, or at least less broadly syndicated ceded risk, seem assured.

So, with that in mind returns are sure to become harder to sustain, unless there is a market moving event of a magnitude that can change reinsurers fortunes on its own. Where reinsurers can change their own fortunes is in becoming more efficient, embracing innovation, expanding internationally to new and emerging markets, new product development and better customer servicing to attract more business, so it’s not all lost by a long way.

With returns getting tougher for reinsurers A.M. Best warns that the market could experience lower ROE’s and higher combined ratios, as commission expenses increase and premiums decline in 2015.

But there are signs that price declines are moderating. Reports from the current reinsurance renewal season suggest that some programmes have been returned to brokers to re-price, as the market refused to support further steep cuts. Catastrophe bond pricing has also shown evidence of a stabilisation of rates.

So while there continues to be some gloom over hanging the reinsurance market, it’s not all bad. Reinsurers perhaps need to become accustomed to lower ROE’s and focus on how to add incremental return to their business through innovation, international expansion and efficient underwriting practice.