Slowdown of ILS capital inflow helped stabilise market at 1/1: JLT Re

Overall, dedicated reinsurance capacity remained at a relatively flat level at the key January 1^st renewal season, driven by a slowdown in the entry of alternative capital, which JLT Re says helped to stabilise an increasingly challenging sector.

JLT Re, the reinsurance unit of brokerage JLT, saw a broadening of rate declines in the global reinsurance market at the January 1^st, 2017 renewals, highlighting a number of market drivers.

The reinsurance broker claims that reinsurance supply was static during the recent renewals, driven largely by a reduction in the entry of insurance-linked securities (ILS) capacity in response to lower returns and the overall, challenging operating landscape.

Several industry observers and analysts have noted the slowed entry of third-party, or alternative reinsurance capital during the 1/1 renewal season, as investors and sponsors alike continue to show discipline in light of further rate reductions and intense competition.

Industry players and analysts, including Munich Re, noted ILS investor and fund manager pricing discipline in 2016, which is promising to hear at a time of broader re/insurance market turmoil. ILS players have been seen to be amongst the first to pullback from unprofitable lines of business during the soft cycle, and the increased sophistication of the space continues to be a benefit.

But despite a notable slowdown alternative capital is continuing to expand its presence and remit in the global re/insurance marketplace, and JLT Re stresses that while a number of sector trends helped to stabilise the market at renewals, near-record levels of dedicated (both traditional and non-traditional) capacity remains a challenge.

David Flandro, Global Head of Analytics at JLT Re, said; “Near-record levels of capital currently remain the dominant force in determining the direction of reinsurance pricing, as excess supply chases relatively muted demand.

“Nevertheless, moderating capital inflows, increasing cessions at the margin, the prospect of higher insured catastrophe losses, reserving volatility, inflationary and interest rate concerns and declining forward reinsurer returns are coalescing to push back against downward pricing pressures.”

Catastrophe losses during 2016 returned to more normalised levels, which along with an increased demand for reinsurance protection (as cedents continued to take advantage of the favourable buyers’ market conditions), growing reserve volatility, evolving regulatory and economic environments, helped to stabilise further rate reductions.

However, as with the entry of third-party capital, which adds market efficiency and diversity but also increases competition and rate pressures, some market drivers discussed by JLT Re have both positives and negatives.

For example, despite catastrophe losses being the highest of the last four years and above the 16-year average, according to reports, they weren’t by any means enough to influence reinsurance sector pricing in a meaningful way and reverse the negative pricing trend, but will result in increased losses for insurers and reinsurers in the fourth-quarter.

“Supply/demand dynamics are constantly evolving and there are early signs of a slight shift as capital levels have started to flatten whilst strategic reinsurance purchasing by some buyers has led to a subtle but notable uptick in demand in recent years.

“Reinsurers have produced returns well in excess of expectations over the last three years, due in large part to favourable reserve development and a sustained period of good fortune with low insured catastrophe losses. 2016 was a reminder that these tailwinds cannot be guaranteed in future years,” said Mike Reynolds, Global Chief Executive Officer (CEO), JLT Re.

The broker continued to explain, in its recently published Renewal Retrospective report, that traditional reinsurance players had to be flexible at the renewal season and adopted a “less rigidly model-driven approach in response to the sustained competition from alternative markets witnessed in recent years.”

Pricing levels between traditional and collateralized reinsurance markets are becoming increasingly aligned, a trend that was evident at the 1/1 2017 renewals season, and JLT Re says that the traditional players showed an increased effort to accommodate client needs, ultimately to avoid losing out on business.

Efficiency and discipline continue to be vital skills and practices of global reinsurance players, both traditional and alternative. The market remains overcapitalized and despite a slowdown in the entry of capacity the supply/demand imbalance looks set to challenge sector returns in 2017, and possibly beyond.

Alternative reinsurance capital remains a challenge for the sector, but it’s important that industry participants look to work with its features and capacity, that continues to claim a larger slice of the risk transfer landscape.

“The challenges presented by reserving volatility, macroeconomic shocks or major losses (or a combination of all three) reinforce the value and efficiency of reinsurance capital in the current marketplace. Given that cession rates remain at historically low levels, now is the time for insurance carriers to re-examine reinsurance as a form of contingent capital.

“Evidence emerged in 2016 that this had started to happen as insurance carriers bought new quota share programmes, aggregate covers, excess of loss buy-downs and adverse developments covers (ADCs). Interest in multi-class and structured reinsurance products is also growing as cedents look to work with trusted markets to develop alternative and tailored solutions that minimise earnings volatility and secure competitive advantages,” said Flandro.