Only a select group of reinsurers have the scale, diversity and financial strength to attract the highest quality reinsurance business and protect their market share, in the face of market softening and continued inflows of alternative capital, according to Fitch Ratings.
Rating agency Fitch believes that the majority of reinsurance firms are so exposed to a protracted softening of the market and a continued entry of alternative reinsurance capital, from third-party and insurance-linked securities (ILS) investors, such that their market shares are at risk of erosion.
In a ratings update on the world’s largest reinsurer Munich Re, Fitch ratings says that it views the firms reinsurance operations as; “One of a select group that have the scale, diversity and financial strength to attract the highest quality business being placed into the global reinsurance market.”
The importance of this cannot be emphasised enough in a marketplace where reinsurers are increasingly facing tiering, with access to business easiest for the top-tier and in some cases smaller, following reinsurers finding themselves signing on less attractive terms to the big players.
Fitch explains that these factors, of scale, diversity and financial strength, are key to firms like Munich Re, and; “Should assist the reinsurer in protecting its market share, in the event of a protracted soft market and the continued entry of alternative capital into the reinsurance sector.”
Scale provides reinsurers with a reach that smaller competitors cannot match, providing them with the means to access business in regions where relationships and feet on the ground are key. It also enables these large reinsurers to see more business, at renewal time the fewer programs that are presented to you as a reinsurer, the more limited your choice of where to deploy your capacity.
Diversity goes hand-in-hand with scale. Only the largest reinsurance firms are truly globally and line of business diverse, allowing them to move capacity to areas of the market where the softening has not been so severe or where alternative capital has not (yet) had so much influence. Without diversity smaller reinsurers are either reduced to becoming following markets in some of the most competitive areas of reinsurance, or to try to produce diversification by expanding into new lines of business through the hiring of new specialists, itself sometimes a risky endeavour.
Finally, financial strength, a key asset to any reinsurance firm, large or small. Financial strength supports expansion efforts, new diversification efforts, pulling back as you may not need to deploy all your capacity and essentially makes a reinsurer more resilient, at least for a while.
Reinsurers who do not have these three qualities are perhaps the most exposed to the softness seen in the global reinsurance market. They are also perhaps most exposed to the influence of ILS and third-party sourced reinsurance capital, which can often beat them on price due to the efficiencies inherent in ILS capital and structures. This leaves some small to mid-sized reinsurer generalists the most exposed.
The two most exposed groups of reinsurers are thought to be the smallest property catastrophe specialists and the small to mid-sized generalists. The reason for this is that small property catastrophe reinsurers struggle to compete with collateralized capacity and are also being squeezed out by the larger specialists and the global reinsurers with scale as well, as the available property catastrophe premium pot shrinks as a result. The generalists perhaps bring to mind the phrase “Jack of all trades, master of none,” suggesting they may be spread too thin across too many areas of the market, without really having the relationships that a specialism can build.
Of course the large reinsurers with scale, diversity and financial strength are not immune to current reinsurance market conditions either, it is having an impact on their results, margins and even in some cases access to business. However firms such as Munich Re (or Swiss Re, Hannover Re, SCOR, the larger Bermuda players and their likes) have the ability to switch focus, as has been evidenced by Munich Re’s growing focus on providing large insurance solutions to corporates and the increasing focus it places on its weather risk hedging unit.
These large reinsurers also sell primary insurance, in many cases, or have the ability to move capacity into their life reinsurance businesses as well. What it boils down to is that the scale, diversity and financial strength they have provides them with many more options for navigating the reinsurance market challenges as the structural or secular change continues to manifest.
However they are not without problems. The largest reinsurance firms acknowledge that there will be tough times ahead and that they are far from immune to the challenging market conditions. In fact reinsurers like Munich Re are themselves becoming more accepting of third-party capital and actively looking at ways to leverage much more of this alternative competitor within their own business, seeing it as an opportunity for growth.
Fitch notes that maintaining its earning metrics at a level commensurate with a ‘AA’ rating is key for Munich Re in the next 12 to 18 months. For this large reinsurer, the results and ultimately pricing achieved at the January reinsurance renewal will be a key indicator of its success and performance for the rest of next year, given the large proportion of its business that is up for renewal at this time.
It’s clear that even the very largest reinsurance firms are not without problems in a soft reinsurance market, with competition increasing and inflows of efficient alternative capital seemingly continuing to rise. However the very largest do have the greatest chance of coming through the soft market unscathed. They are also the most likely to be able to swallow up lesser competitors, should any get into trouble and look like attractive options.
As Fitch says, the results and pricing of the January reinsurance renewals are likely to be a key indicator of future performance for these firms. That is going to make the next reinsurer results season a particularly telling one.