Reinsurance price softening broadens, overcapacity continues: Willis Re

Overcapacity in the reinsurance market, created by the convergence of well capitalised traditional reinsurers, continued inflows of capital from third-parties and new entrants, has caused a soft buyers market across nearly all reinsurance lines at renewal, according to Willis Re.

The reinsurance broker is the latest to report on market conditions at the key January 1 reinsurance renewals and Willis Re, like its competitors, says that this renewal season has seen some of the broadest softening across the reinsurance market in many years.

Challenges abound, said Willis Re, affecting not just traditional reinsurers but new capital sources and alternative players as well. These include declining pricing, new capacity and new entrants to the market, low interest rates, increasing retentions from large reinsurance buyers, diminishing reserve releases, expanding terms and conditions and increasing regulatory oversight.

John Cavanagh, CEO of Willis Re, commented on the renewal season; “The key influence on the 1 January renewals has been overcapacity triggered by a number of converging factors. Strong 2013 results have bolstered traditional reinsurers’ already strong balance sheets. New capital from non-traditional capital market sources has grown to reach US$50 billion. These factors have been compounded by muted demand from buyers arising from the longer term trend of better regulation, which has in turn led to a better understanding and management of tail risk, as well as the trend of major insurance groups to retain more reinsurance premium volume and risk on their own growing balance sheets.”

Soft market conditions are no longer solely visible in property catastrophe reinsurance, according to Willis Re, with price softening now occurring across most of the reinsurance market. Rates have declined at January 1 renewals across most lines of reinsurance business, said the broker, with compressed margins on excess of loss contracts and ceding commissions increased on pro-rata treaties for large and sought after clients.

Reinsurers are fighting back and trying to adapt to the new market conditions that all of this capital has resulted in. Willis Re has seen a number of adaptations among traditional reinsurers seeking to hold onto market share or expand out into new areas of the market.

Peter Hearn, Chairman of Willis Re, commented; “Faced with these market headwinds, reinsurers are adopting a variety of strategies. Larger reinsurers are using their balance sheet strength and technical ability to offer more capacity and more complex, multi-class, multi-year deals. Others are expanding into specialty lines and many have developed multi-channel capacity offerings seeking to use their underwriting expertise to deploy capacity on behalf of capital markets. Additionally, we have seen the rise of pooling arrangements that give smaller reinsurers the opportunity to access business they might not otherwise see in their local markets.”

Willis Re says that while reinsurers have seen strong performance in 2013 it has not been due to strong pricing and restrictive terms and conditions, which is where reinsurers have traditionally sought to excel. Instead it has been due to low catastrophe losses and the very quiet hurricane season.

With reinsurers now offering more flexible and broader terms and conditions at lower prices it has to be wondered how reinsurer performance will react were we to have a much larger catastrophe loss year in 2014. As we wrote earlier today, there is a growing risk that reinsurers are giving away too much for too little return and this could come back to bite some of them.

The overcapacity has been most evident in U.S. property catastrophe reinsurance renewals, where Willis Re reports risk adjusted rate reductions of up to 25%. On international property catastrophe reinsurance Willis Re reports rate declines of up to 15%.

The influence of capital markets backed and ILS capacity, which Willis Re says has grown to $50 billion, is most pronounced in U.S. property catastrophe lines. These programs have seen combinations of collateralized, traditional and securitized reinsurance solutions being used throughout the program structures.

Conversely, international property catastrophe placements continue to be serviced predominantly by traditional reinsurers, based on long-standing relationships, strong balance sheets, and competitive pricing underpinned by mature capital diversification models, said Willis Re.

Demand for reinsurance remains a more critical issue than supply of cover in the market right now. Insurance penetration and the resulting reinsurance demand is not enough to offset the reduction in reinsurance buying in mature markets, said Willis Re. One brighter note is that Willis Re has seen some evidence of new reinsurance placements being planned for Q1 as a result of savings made at the renewals. It will be interesting to see how these are transacted and structured.

Interestingly Australia seems to be one territory where traditional reinsurers have turned to as ILS capacity increased its activity in U.S. property catastrophe. Willis Re says that traditional reinsurers are looking to regions like Australia to deploy capacity, perhaps seeking regions where ILS use is not so prevalent. However, ILS players are looking to regions such as Australia as the next expansion opportunities so it will be interesting to see whether reinsurers can hold onto that property catastrophe market in the future.

In Central and Eastern Europe Willis Re said that the catastrophe losses suffered in 2013 have not resulted in broad hardening, with most programs seeing price reductions. Some of the programs worst affected by the European floods have seen a little upwards pricing pressure, but nothing significant.

Capacity from the ILS market emerged in Europe, said Willis Re, but at this time it has not had a major impact on the market as overcapacity continues from traditional players. Aggregate protections have been more of a feature for Europe, perhaps a result of the number of small to medium catastrophe losses suffered in 2013. The ILS market showed more interest in Germany, where loss affected lines saw some rate increases, but at this stage it has only had a modest impact.

UK reinsurance renewals saw abundant capacity and collateralized markets beginning to make some inroads here. The collateralized capacity is mainly coming into the UK market via fronted traditional paper, said Willis Re.

For the capital markets specifically, Willis Re said that catastrophe bond spreads have continued to decline, but not across the board. At the same time terms and conditions for catastrophe bond coverage has become more flexible, with an increased availability of indemnity protection evident in the market.

Both sidecars and ILS funds have continued to grow, said Willis Re, despite the fact that expected returns have declined. This clearly demonstrated the lower cost-of-capital in ILS and investors appetite to continue to support this sector. However, the quiet hurricane season in 2013 has led most investors to achieve excellent returns across ILS investments last year.

Willis Re reports 2013 catastrophe bond and ILS issuance as $7.1 billion. This is lower than Artemis’ reported figure of just over $7.64 billion, but Willis Capital Markets & Advisory does not include all the transactions that Artemis includes in the Deal Directory.

Willis Re believes that 2014 is going to be testing for reinsurers, saying that this year will test the skill of both reinsurers and intermediaries alike as buyers continue to seek price reductions and improved terms in this softening market. Willis Re also warns reinsurers to watch out on relaxing terms and conditions, saying; “Experienced reinsurers will remember that the relaxation of terms and conditions more so than price reduction caused the real damage in the last soft market cycle.”

Read our other January 2014 reinsurance renewal coverage:

– Guy Carpenter: Capital, convergence, competition = reinsurance renewal rates fall

– Aon Benfield: Buyers market at January reinsurance renewals