ILS capital slow-down a “healthy response” to reinsurance market: A.M. Best

The slow-down in the growth of insurance-linked securities (ILS) and reinsurance-linked investment capital and capacity is a “healthy response” to current reinsurance market conditions, according to rating agency A.M. Best.

The evolution in global reinsurance markets is being fueled by the abundance of capacity, A.M. Best says in a new briefing report. But the slowing speed of entry of alternative capital into ILS investments and collateralised reinsurance is evidence of discipline and ultimately could be helping to stabilise pricing in some areas.

A.M. Best’s commentary aligns well with that of the leading reinsurance brokers, on market conditions at the key January reinsurance renewal season.

Many have cited the evident discipline among ILS fund managers, as they have controlled inflows of new capital in order to match opportunities to deploy it as reinsurance capacity effectively at the renewals. This has contributed to a slow-down in price declines in the key U.S. property catastrophe reinsurance market, as ILS discipline helped to hold up prices.

A.M. Best’s briefing notes the continued challenges faced by participants in the global reinsurance market, saying that it is not the depth of the soft market that is the major threat to reinsurers but the duration of the prolonged softening.

With other observers, like broker Aon Benfield, suggesting that things really are different this time and that the reinsurance cycle is likely dead, or permanently changed, A.M Best notes that the passage of time is required before we will really know just how structural the changes we are seeing may be.

But for the moment reinsurers are seeing their results buoyed by a lack of losses, capital management strategies and favourable reserve releases. However A.M. Best notes that these reserve releases are “unsustainable over the long-term.”

“Conditions will remain competitive and challenging, as primary companies are expected to continue retaining more business and/or seek better terms and conditions for sharing their pro table business,” the rating agency continues.

Meanwhile margins are expected to continue to be compressed, although A.M. Best notes the slowing declines of pricing in some risks and regions, particularly U.S. property catastrophe risks.

“Third-party capital continues to seek a larger piece of the pie, but the speed of capital market capacity entering the market, seems to have slowed as compared to the prior year and some collateralized markets have held capacity flat, unable to find suitable opportunities. In A.M. Best’s opinion, this is a healthy response to the current market environment,” the rating agency explained.

With returns reducing, premiums dropping and margins being compressed, at the same time as terms and conditions have expanded, “the need for disciplined underwriting should remain the focus,” A.M. Best urges.

There is also evidence of discipline at traditional reinsurance companies, the rating agency explains, with some companies appearing to “be reducing their appetite for underpriced reinsurance business in favor of other more attractive business opportunities.”

The reinsurance market has always been “a leader in terms of evolution” but the market has evolved incredibly rapidly in recent years, A.M. Best notes. Changes in the sector have historically been cyclical, but now many are questions whether we have seen a permanent structural adjustment to the market.

“The market is operating in a “new normal” of abundant capacity from traditional and alternative sources, low interest rates, and thinner reinsurance margins driven by intense competition against shrinking demand for reinsurance cover,” the rating agency concludes from this.

Ultimately, the changes the reinsurance industry is going through will result in a need for new business models, more efficient capital, lower expenses, while greater scale and diversification can help to offset some of the need for efficiency. However, as the soft cycle prolongs the need for efficiency no matter the scale or reach is likely to become increasingly evident.

“The new reality for the reinsurance market will reflect an industry where returns are less impressive and underwriting will have to become a larger contributor to profits and returns,” A.M. Best explains.

In order to achieve this discipline will be essential, hence it is encouraging to hear the reports that ILS players are already demonstrating this and reinsurers are too.

Key for the future will be “cautious risk selection, more diversification of product offerings, a wider geographic reach, and conservative loss picks,” A.M. Best explains.

Alongside this, an “ability to take advantage of the new “cheaper” capital coming into the market from investors that do not have the reinsurance and underwriting expertise, could actually lead to significant success for some,” the rating agency notes.

However, “not everyone will win in the end” and it is the reinsurers that have shown underwriting discipline and conservative reserving who can ride out this soft cycle the longest. Developing a book of business that will “remain relevant for today’s market and that allows for quick shifts in and out of lines of business depending on market conditions” is key A.M. Best says.

Alongside this the ability to effectively manage third-party capital will be increasingly important for reinsurers and winners will be found among “companies that have created expertise in managing third-party capital to their own advantage.”

So the slowing growth of ILS is at this time healthy, according to A.M. Best, reflecting discipline amongst those managing ILS capital in managing investor inflows to match underwriting opportunities. However the pressure for traditional reinsurers remains and looks set to continue, with the business model needing to adjust to what could be a permanently softer reinsurance market.

Read all our reinsurance renewals news and analysis here.

Also read:

– Signs of discipline despite soft reinsurance market: Aspen Re CUO.

– Reinsurance rate declines slow, ILS discipline may attract capital: Guy Carpenter.

– ILS market discipline helps slow reinsurance softening: Willis Re.