As stiff competition and an oversupply of capital intensifies pricing pressures in property catastrophe reinsurance, RBC Capital Markets (RBC) analysts predict future 2015 renewals to bring much of the same as the beginning of the year.
Investment bank RBC’s recently published report, ‘European Reinsurance, January renewal reporting season – what to expect,’ predicted that reinsurers would report price declines in the low single digits, resulting in a further deterioration of their combined ratios.
“The big question, in our view, remains whether this downturn is cyclical or signals a structural change in the industry. We believe that elements of this pricing downturn in reinsurance are structural,” explains RBC.
The debate as to whether the current low-cost of risk capital is a “new normal” for the market was something Artemis wrote about recently, when we discussed reinsurance broker Aon Benfield’s January 1st reinsurance renewal report.
While it’s hard to say just how much of this change in reinsurance market dynamics is cyclical or here to stay, RBC notes that the increased entrants of new players, bringing waves of alternative capital into the sector, is almost certainly here on a more permanent basis.
Much of the RBC report focuses on price declines, with a view that reinsurers will continue to work with longer tail lines of business such as casualty in search of better yielding business, while some “reinsurers will continue to use cheaper retrocession pricing as a means of offsetting price declines in their reinsurance portfolios.”
Akin to that of 2014, RBC expected price declines of between -1.0% to -4.0% to be reported by reinsurers, with any deviation being driven by business mix and a varied use of retrocession between companies. The firm’s expectation was in line with the majority of reports seen so far. Interestingly Swiss Re has yet to report, so it will be interesting to see whether its results on Thursday reflect these numbers.
In light of expected price declines for the majority of reinsurance business lines, the study signals that RBC also predicted further deterioration of firms’ normalised combined ratio assumptions, as highlighted in the chart below.
RBC states that; “The data so far has not been promising – property catastrophe lines down 11%.” This view is very much in line with what many market experts, analysts and investors had been expecting.
Another benign catastrophe loss season, coupled with an abundance of excess traditional reinsurance capital and new alternative capital, ensured continued widespread softening across most business lines in the closing months of 2014 and at the January renewals. RBC believes that this trend is expected to continue for the foreseeable future.
When discussing how reinsurance companies can help to mitigate the impacts of a softening market, RBC notes that; “One way that reinsurers will be able to minimize the impact of falling reinsurance prices is to purchase more retrocession cover at cheaper prices.”
The investment bank expands on ways certain reinsurers can navigate through a challenging market environment, advising that as “new entrants requiring lower returns in this line of business, the reinsurers have begun to shift business towards longer tail lines of reinsurance such as US casualty and into specialty lines reinsurance too.”
RBC expects this trend to continue throughout 2015 as well, but does warn that a shift in business mix has the potential to lead to wider softening as well as the potential for more volatility in loss and combined ratios.
Looking forward, the report reveals that RBC predicts further price declines, creating greater pressure on reinsurers’ earnings across 2015.
As record levels of capital flood the market “with little sign of significant new growth opportunities for the industry,” RBC’s outlook for 2015 is worse than that of 2014.
Despite this, the study notes that price declines still have some way to go before the market becomes truly soft, or even as bad as previous soft cycles.
RBC concludes that; “We would like to believe that the industry is more disciplined than in the 1990s. There is less focus on volume than in the past, there have been dramatic improvements in capital modelling and current management teams have all witnessed the destructive power of a soft reinsurance cycle.”
RBC is hopeful that discipline will ensure that pricing only softens so much, but the report suggests that pricing will be driven by the lowest-cost denominator and in many lines of business, such as property catastrophe reinsurance, that could be insurance-linked securities (ILS) capital and collateralized reinsurance players.
That is more hopeful than some other outlooks for 2015, which suggested that rather than cost-of-capital setting the floor in reinsurance pricing it would be capacity driving the reinsurance cycle, with the least conservative setting the price.