Some re/insurers rely on investment returns to make a profit: PwC

In a review of the prospects for the London insurance and reinsurance market in 2015, PwC notes that with margins down on underwriting and an expectation that combined ratios will rise, some re/insurers are “materially reliant on investment returns to make a profit.”

This is an interesting point made by PwC today. It’s been clear that some insurers and reinsurers are turning to either more active management of investment portfolios, or in some cases taking on a little more risk, for some time as they seek to boost their returns. However in the review of the London market PwC say that as many as one in five could already be reliant on their investment returns just to turn a profit.

Underwriting confidence is down in the London insurance and reinsurance market, PwC said today. With the January 1 2015 renewal just a few weeks away, PwC’s review of the market suggests that London market participants are heading for an average combined ratio of 97% for 2015, which makes the contribution of the asset side ever more important.

When combined ratios begin to rise, likely partly due to prior year positive reserves beginning to wane, all that insurers or reinsurers can do is reduce expenses or boost their asset return. However for one in five to already be relying on the asset side just to remain profitable is a little concerning as it suggests that any degradation of underwriting results for the London market, particularly at the same time as some economic stress or loss hit asset portfolios, could see some re/insurers with spiraling combined ratios and becoming unprofitable very quickly indeed.

The continued abundance of both traditional and non-traditional reinsurance and insurance capital has dampened the potential for rates increases and led to substantial rate declines over the last year, notes PwC. Even lines of business like Aviation Hull War is expected to be largely flat by the end of the year, despite the losses suffered and insurers expectations that rates would increase.

For 2015, PwC says that there is “significant softening anticipated across most other classes.” Property reinsurance and the energy classes of insurance and reinsurance business are expected to be most affected and PwC’s market view shows rate reductions of over 10% are anticipated across most lines.

Abundant capacity is putting significant pressure on energy lines of business, said PwC, with property cover both onshore and offshore risks softening despite some losses.

In property reinsurance the combination of low interest rates, limited growth in traditional insurance markets declining margins, the influx and influence of insurance-linked securities (ILS) capacity and soft market conditions, mean that reinsurers are having to work harder than ever just to attract business.

PwC continues to forecast that the mid-sized generalists in the reinsurance space could find it particularly difficult to maintain their competitive relevance and sustain investment in the currently challenging and structurally changing reinsurance market.

Harjit Saini, who led PwC’s London Market review, commented; “The continuing soft market conditions appear to be having an impact on insurer confidence and outlook in the London Market. Insurers are combating a cycle of rate decreases and changes to terms and conditions, which are increasing pressure on management teams. Such as, for example, the removal of the seven day notice cancellation for Aviation insurers in some instances).”

Despite the challenges, the London market continues to be a profitable place to do business, just not for everyone, suggests Saini; “The sector, however, continues to deliver good returns because of the benign loss conditions and, indeed, rates on Catastrophe are still equivalent to the pre-Katrina levels, where the market was profitable. Also, in our view, Casualty rates are at levels above the 1998-2000 period of the last very soft market.”

Bryan Joseph, Global Actuarial Leader at PwC, added; “Many reinsurers need a radical re-think of where and how to compete. With prices low and direct competition from Insurance-Linked Securities, clients can afford to gravitate to a select panel of higher rated, often larger, reinsurers. This is leaving some of the smaller and less well rated counterparts in the margins.”

Joseph insists that for some re/insurers there is no place to hide from the increasing market pressures; “Fighting over the commoditised crumbs or hunkering down in the hope of a more favourable rating environment is not a viable strategy for survival in the current market. Unless the undifferentiated generalists change tack, it’s only a matter of time before they’re absorbed or squeezed out of the market altogether. The urge to merge continues to be pressing and our estimate of about 40% of companies being at risk of the squeeze continues to hold.”

The comment that as many as one in five re/insurers may already be reliant on investment returns to make a profit are intriguing. With traditional insurers and reinsurers often stating that hedge fund strategy reinsurers are ‘cash flow underwriting’, PwC’s analysis of the London market suggests that a fifth of them could effectively be doing this already, making next to zero profit on underwriting with results boosted by the asset return.

If these one in five re/insurers decide they need to make more of a return from the asset side we could suddenly find a large proportion of the market effectively following a hedge fund style re/insurer strategy just to be able to survive.

It would be more likely that investors in these one in five insurers and reinsurers wouldn’t allow them to take on too much asset risk, leaving only one other way out if the underwriting return continues to decline. Consolidation, merger or acquisition would seem like the only chance of survival for these marginalised players who cannot profit off their underwriting in the current market environment.