Swiss Re binds less renewals as prices decline, business model adjusts

Reinsurance firm Swiss Re underwrote 18% less renewal business at the 1st January 2017, renewing $8.5 billion of a possible $10.3 billion, as it continues to navigate softening reinsurance markets and looks to protect its profitability.

The reinsurer cites “disciplined underwriting” and a reduction in capacity across almost all of its market segments in January, as it tailored its book to try to extract maximum profit, in its fourth-quarter and full-year 2016 results announcement today.

These shifts can leave capacity holes in the reinsurance market, but as readers know as long as it meets return requirements there is efficient capital ready and willing to step in to help fill the gaps that emerge.

The reinsurer reported that, based on its own measure of profitability, the risk-adjusted price quality of the book it underwrote only came out 1% ahead of its breakeven target, at 101%, a decline from the 102% price quality it experienced at renewals a year earlier.

With a 101% price quality on this renewed business Swiss Re is targeted, for that portion of its book which will largely have been constructed from property and casualty reinsurance renewals, at somewhere just above its Group return on equity (RoE) target of 700 basis points above risk free over the cycle.

The P&C reinsurance group at Swiss Re targets an RoE of 10% to 15% across the cycle, which it achieved in 2016 with a result of 16.4%. In 2017, based on another 1% decline in price quality and a reduction in capacity deployed into this business, it may be a difficult task.

This could be especially difficult as Swiss Re itself is forecasting a combined ratio for its P&C reinsurance business of around 100%, assuming an average burden from large losses throughout the year.

This is further evidence of the reduction in margin in P&C reinsurance business, which of course makes an efficient business model, efficient capital and low costs especially important.

It also goes some way to explain the continued push into large tailored and corporate solutions transactions, by the big reinsurance players like Swiss Re. But with that business not performing as well as planned in 2016, it remains to be seen whether that push proves especially profitable over the longer-term.

Group CFO David Cole said that pricing conditions are as low as the reinsurer can go, in an interview today, explaining that the pull-back and portfolio management is aimed at protecting the reinsurers results.

Overall market conditions are challenging, Swiss Re said in its results today, with Casualty reinsurance prices holding up the best in P&C Re. But the group has seen rate declines in property catastrophe and specialty reinsurance slowing down, which is encouraging for maintaining profits.

Pricing in commercial insurance, where Swiss Re’s Corporate Solutions division focuses, are especially challenging, Swiss Re notes. This is likely due to reinsurers shift of capacity to these markets, in search of better returns, a strategy that has yet to be proven as especially profitable over the longer-term.

This business renews all the way through the year, being primary insurance, but it can be particularly lumpy and lead to unexpected losses, as has been seen with man-made loss events that hit the likes of Swiss Re this year.

The pull-back on reinsurance premiums written at the renewal was led by operations in the Chinese market it seems, as Swiss Re said that the new solvency regime under C-Ross meant that while it had reduced capacity deployed in all segments, this was particularly evident in quota share business in China.

This is another opportunity area for the large reinsurers, cited as a key market where alternative capital would find it hard to follow just a few years ago, but now the local market players are taking increasing shares of reinsurance quota share business there, making it less attractive for foreign reinsurers, despite their significant investments in the region.

Swiss Re itself notes that business models across insurance and reinsurance are set to change.

Both digitalisation and the influence of capital market backed models are driving developments that may not have been anticipated even 10 years ago.

On the one hand, the response from major reinsurers has been to the negative price cycle challenges; doubling-down on large tailored solutions, expanding into direct corporate risk insurance, focusing on new markets such as China, discounting heavily for diversification in key markets to maintain shares (look at European and Japanese property catastrophe program pricing), and seeking to close protection gaps in other markets where margins remain minimal.

On the other hand, large reinsurers have responded to the changing world by; investing heavily in technology, expanding research arms, developing proprietary models, spending heavily on working alongside political and development entities, investing in start-ups to jump on the Insurtech wave and seeking to update the perception of insurance from the customer through marketing and a change in tone.

These are all positive and necessary steps, a clear shift in business model and moving with the times, positioning major reinsurance companies for the future for sure.

But with pressure still on, margins declining, RoE’s down, business opportunities shrinking in core areas (the pull-back), and forecasts suggesting near break-even profitability ahead, one has to question where the turn-around comes from for global players?

Are the profits of previous years gone for good, or can the likes of Swiss Re generate new revenue streams through its innovation initiatives, while also encouraging greater uptake of insurance and ultimately reinsurance across the world?

Will spending heavily on innovation, going direct, targeting emerging markets and diverting capacity truly reap the rewards that firms like Swiss Re hope for over the longer-term?

It’s uncertain at this time what the future looks like for the reinsurance market, except to say that efficient capital and business models (so alternative, ILS and others) have a clear role to play and also an opportunity to take increasing shares, when the major players deem segments of the market no longer meeting their cost of capital.

Cost of capital and meeting it remains key in P&C reinsurance, and based on Swiss Re’s pull-back at the renewals it seems a growing chunk of the business is no longer supportive of this for this particular global market player.

The business model is changing across the industry and Swiss Re’s moves are evidence of this. It’s going to be some years before we know how successful such shifts are for the major reinsurers, but the positioning is positive and should leave these global players ready for new opportunities that will no doubt emerge.

Of course the move to new ways of doing business, and the pull-back on established areas of the market, will also leave gaps and opportunities for the efficient capital business models to double-down and secure an enlarged area of the reinsurance market for themselves. Although it’s important to note that gaps in the market are likely being filled by other traditional players first, with ILS supporting for now.

However this trend plays out over the coming years, these shifts in business model make for interesting times ahead.