Signs of rationality in reinsurance, as capital growth slows: Willis Re

There are signs that an equilibrium between reinsurance capital supply and demand may be emerging, leading broker Willis Re to suggest that the “emergence of rationality” is being seen, as capital growth in the sector slows down.

The oversupply of capital has been one of the key factors driving the highly competitive market conditions in reinsurance, resulting in prolonged softening and driving reinsurers to expand terms and conditions to win business.

In its latest reinsurance market report, broker Willis Re explains that they are beginning to see the first signs of rationality emerging in the market, as the rapid growth of capital has begun to slow down.

John Cavanagh, Global CEO of Willis Re, commented; “Markets clearly continue to face significant over-capacity and competitive pricing conditions, and overall underwriting margins remain under substantial pressure. But the evolution in the Willis Reinsurance Index is another indicator that we are beginning to see the emergence of rationality in the market – just as we saw price stabilization beginning to emerge at 1/6 and 1/7, there may now be evidence of capital stabilization as supply and demand begin to equalize.”

Faced with the continued overcapacity and resulting widespread pricing pressure, the growth in global reinsurance capital has stabilised during the first-half of 2015, according to Willis Re’s report.

Using its Willis Reinsurance Index, which tracks a group of 43 reinsurance companies from around the world, the broker reports that dedicated global reinsurance capital from both traditional and non-traditional (or alternative) sources remained static at $425 billion.

That figure is unchanged from the record level reached at year-end 2014 which of course suggests that, while capital hasn’t grown, the pressure from record levels of it is unlikely to diminish quickly.

This levelling off of reinsurance capital was also noted by competitor Aon Benfield in its latest reinsurance sector report yesterday, which highlighted that while overall capital levels were roughly static, alternative reinsurance capital had actually grown at a faster pace than traditional in 2015 so far.

Willis Re puts the levelling down to reinsurers having been actively managing capital at accelerated rates, returning greater amounts to shareholders as “acceptably profitable capital deployment opportunities in the market diminish.”

Movement in shareholders funds of Willis Reinsurance Index, USD B

That last quote is key we feel. It seems that observers have been celebrating a return of capital at a time when there surely must be opportunities to invest in innovation in order to seek out profitable avenues of growth. Could reinsurers regret returning so much capital in future, particularly if losses jumped? It’s certainly possible.

Demonstrating just how massive the return of capital has been in 2015, Willis Re explains; “In the first half of 2015, the publicly listed companies within the Willis Reinsurance Index have returned virtually all earnings to shareholders – a total of $16 billion – via share buybacks and ordinary and special dividends. This compares to just $9.7 billion returned to shareholders across the full 2014 year.”

Additional capital returns are expected at year-end from a number of reinsurers, if they cannot find profitable avenues to put the capital to work, Willis Re says. That could signal that 2015 passes without much, if any, growth in overall reinsurance capital levels, which could moderate the price environment more than expected in January if new demand can be generated or appears.

Merger and acquisition activity is also impacting the levels of capital in the reinsurance market, Willis Re explains, with 10.5% of shareholder’s equity in the Willis Reinsurance Index caught up in M&A activity right now.

But, with capital still at record levels in reinsurance, the pressures do remain and Willis Re highlights that returns-on-equity (RoE’s) continue to display the effect of high competition and capital levels.

Willis Re now believes that reinsurance firms in its Index are operating an underlying RoE of just 5.1% (compared to a reported 11.1% aggregate), based on a more typical catastrophe year and excluding prior year reserve releases. At the end of H1 2014 that number stood at 7.8% (compared to the reported aggregate of 12.8%, showing how conditions have worsened steadily throughout the last year for reinsurers.

Cavanagh explained this, saying; “The Willis Reinsurance Index also demonstrates that we have entered a new reality for underlying reinsurer RoEs. Yet while a significant shift in RoE levels is being accepted by shareholders, the profitable deployment of excess capital remains a key challenge for reinsurers and is exacerbated by the low levels of loss activity.”

With global insured catastrophe losses now at their lowest level since the first-half of 2006, Willis Re expects that will result in market pressures continuing to be exacerbated.

Also exacerbating the pressure for the traditional reinsurers, is of course alternative reinsurance capital. Willis Re now puts capital from alternative markets at $65 billion, only one billion shy of Aon Benfield’s latest estimate of $66 billion. That’s technically flat with the start of the year, but still outpacing traditional dedicated reinsurance capital.

This is the closest the two brokers estimates of alternative capital have been, perhaps signifying an increasing level of transparency in the sector, over where the ILS capital has been deployed and by who, making the calculation easier.

Willis Re has noted the same as Aon Benfield, that while traditional reinsurance equity capital has shrunk over the first six-months of 2015, alternative capital has continued to grow as a proportion of global dedicated reinsurance capital, albeit at a reduced pace.

That suggests that alternative capital and ILS is taking a greater share of programs and also penetrating more deeply into the market than it was previously, when traditional capital was still growing rapidly as well.

While capital management is a sign of rationality among reinsurers, it perhaps could also be interpreted as a sign that they don’t know what to do with the capacity and so are returning it without much of a thought for alternative options.

“The outlook remains challenging for the remainder of 2015 as markets continue to face significant over-capacity and competitive pricing conditions,” Willis Re explains, suggesting that no matter what is done with capital levels it will take something much larger, like a major catastrophe event to really deplete industry capital and restore some true equilibrium.

Meanwhile the results are flattered by prudent reserving, which means that as the pressures continue; “Those who have reserved most conservatively during the soft market will reap the benefits of their approach,” Willis Re explains.

But even with all the pressures that are faced by reinsurance firms, as the industry capital levels remain high and with it the levels of competition, reinsurers and the reinsurance space continues to be seen as an attractive place to invest.

“Ultimately, however, reinsurance remains attractive to investment capital in the long-term despite the diminishing underwriting and investment returns being delivered, as recently evidenced by Exor’s purchase of Partner Re,” Cavanagh explained.

For as long as that continues and investors with the ability to operate at lower costs-of-capital continue to access reinsurance returns, or invest in firms in the reinsurance market, the pressure on the sector is likely to remain no matter how rationale it may seem.

Read all of our Monte Carlo Rendez-vous 2015 coverage here.