Soft market forecast, led by reinsurance, third-party capital a factor: Nomura

Equity research analysts at Nomura, the Japanese investment bank and financial group, are the latest to cover the reinsurance sector and cite the impact of third-party capital inflows on the reinsurance market. Nomura forecasts a soft market by early 2014 for U.S. property and casualty (P&C) lines with reinsurance leading the market down with new capital inflows pressuring pricing.

Recently we’ve seen a number of reports from equities and market research analysts, covering insurers and reinsurers, and each has cited the growing influence of the convergence of reinsurance and capital markets, and the continuing inflows of new capital as putting pressure on the re/insurance sector.

Credit Suisse research analysts said; “No reason to believe the growth trajectory of insurance-linked-securities reinsurance structures and the subsequent pressure it puts on pricing will dissipate for the foreseeable future.” Morgan Stanley analysts said that the mid-year reinsurance renewals could see the participation of alternative reinsurance capital grow to as much as 30%. Macquarie warned that they see the influx of third-party capital driven reinsurance capacity as a ‘bear case’ for the reinsurance sector. Finally, Meyer Shields of Keefe, Bruyette and Woods warned that the incremental capacity that pension funds are bringing to the reinsurance space could dampen returns, both for reinsurers and ILS funds.

So the equity analysts have really got their teeth into the third-party reinsurance capital trend this year, which demonstrates that the insurance-linked securities, reinsurance-linked investments space and participation of the capital markets in reinsurance is really gaining pace.

Nomura published a report covering a number of companies in the insurance and reinsurance space yesterday and were consistently bearish on the prospects for most of them over the next six to twelve months. We believe it is the first time Nomura has initiated coverage on the sector, at least in recent years.

Nomura initiated coverage on the P&C sector with a Neutral rating. Coverage includes a Neutral rating on the following firms; AIG, Allstate, Aon, AXIS Capital, Chubb, Marsh & McLennan, PartnerRe, Travellers, Willis Group and XL. Interesting that they are covering the major brokers too and put neutral outlooks on their prospects as well.

Nomura analyst Clifford Gallant commented; “Following two years of rising pricing across most product lines in the U.S. P&C industry, a new, soft market should emerge by early 2014. Reinsurance is leading the market down. During April renewals, the market saw 0-5% rate declines, and midyear June renewals are expected to be down as well. Primary commercial looks okay, but not for long. As rates decline, we expect ROE and EPS projections to be cut.”

Nomura are the first to predict a soft market in P&C insurance, and also in reinsurance, judging by their comments. It’s interesting as we are accutely aware that some of the new sources of capital flowing into the reinsurance space have significantly reduced costs of capital and are actually happy with pricing on many lines of business. Of course there are other sources of third-party capital who aren’t so happy with the decline in rates.

This begs the question; when do lower rates and pricing equal a soft market? Perhaps it is all in the perception of prices, so soft for traditional insurers and reinsurers and simply acceptable for alternative reinsurance capacity providers. Questions such as these highlight the changing motivations in the reinsurance underwriting marketplace.

ACE were initiated at Buy, the only firm in the report to receive such an outlook, with analysts citing the ability of its specialty business to drive higher returns. Gallant said; “We expect its specialty businesses to drive higher returns with better growth and profits than most competitors. In an improving global economic environment, we expect growth to ramp up quickly and ROEs to hit mid-teens (from a 3-year average of 10.7%). Long term, we think that ACE’s growth prospects, balance sheet strength, and stability of earnings make the shares a compelling Buy.”

One firm has received a Reduce rating from Nomura, RenaissanceRe Holdings. Now this may be a little surprising as RenRe is often considered one of the reinsurers best positioned to adapt to the changing capital landscape of the reinsurance marketplace, especially as it has a long track record in managing third-party capital in sidecars and fund structures.

Nomura set a Reduce rating for RenaissanceRe and an $80 per share target price. RenRe’s shares have lost value over the last few months, having fallen from around $94 per share in mid-April to $84.67 at yesterdays market close. Nomura explained that due to the pressure on pricing created by inflows of third-party capital, it expects abundant capital and increased competition to have a negative effect on reinsurance pricing and in turn share prices. We suspect this sentiment would apply to many of the largest catastrophe reinsurers.

Gallant wrote on RenaissanceRe; “An impressive track record of high ROEs and underwriting profits despite being a catastrophe-focused reinsurer give the stock a well-deserved premium valuation versus peers, in our view. However, new sources of capital have been rapidly entering the catastrophe reinsurance marketplace, which we expect will pressure pricing. We believe shares could decline in a worsening pricing environment. Our PT of $80 reflects a 1.1x book value multiple, a premium to the peer group at 0.9–1.0x, but below peak multiples of a rising-rate environment due in part to increased competition that will pressure pricing.”

The expectation is that new sources of capital will continue to enter the catastrophe reinsurance market over the rest of 2013. Third-party capital is also beginning to flow into other lines of business, specialty being one which some ILS fund managers and colateralized reinsurance firms are focusing on. As this continues we can’t see the pressure on rates getting any less, although rates will likely stabilise.

We now know that reinsurance pricing at the June 1 renewals has been pressured and we expect any renewals on July 1 to experience the same. There are always a number of Asian renewals in the Autumn which could provide a useful barometer for how far this pricing pressure is exerting its influence across both reinsurance and insurance lines, but the real test for the market now will be the January 1 2014 reinsurance renewals and how pricing reacts then.

Of course we still have the 2013 Atlantic Hurricane Season to make it through without any meaningful losses to the reinsurance market, and any other major global catastrophe events could change the pricing outlook considerably. However the sentiment in the market is increasingly confident that the capital flowing into the catastrophe reinsurance space is either sticky or will be quickly replaced after any major events.

Read our other analyst report coverage (most recent first):

– ILS market to continue growing, keep pressure on reinsurance rates: Credit Suisse

– Alternative reinsurance capital could capture 30% of mid-year renewals: Morgan Stanley

– Macquarie bearish on third-party capitals impact on reinsurance firms

– Pension fund capital inflows could dampen returns over time: KBW