Q2 cat losses not enough to limit reinsurance pressures: Morgan Stanley

At an estimated $14 billion, global insured catastrophe losses in Q2 2016 exceeded the ten-year average, with insurers, reinsurers, and ILS players likely to take a hit. However, ongoing market pressures and rate declines suggest losses aren’t sufficient to turn the softening market, according to Morgan Stanley.

In recent years the benign loss environment has been one of the numerous headwinds facing global reinsurers, exacerbating the implications of the flow of alternative reinsurance capital into the marketplace, contributing to the softening environment.

Rates across the majority of insurance and reinsurance business lines have fallen at consecutive renewals, with property catastrophe lines (the main focus of alternative reinsurance capital) witnessing the steepest declines.

Industry observers and leaders have discussed the need for a substantial, market turning event to take place in order for capacity to leave the market and a turn in pricing to follow. However, after a prolonged period of reductions and mounting pressures, some in the space have said this will require a $50 billion, or higher loss event.

Analysts at Morgan Stanley have released a report that discusses losses in the second-quarter of 2016, noting that at an estimated $14 billion, this is higher than the ten-year historical Q2 insured cat loss average of $9 billion.

The firm expects reinsurers to feel the impact of property and casualty (P&C) losses in the second-quarter, adding that insurance-linked securities (ILS) capital could also assume some of the losses via collateralised reinsurance placements, an expanding sub-sector of the ILS space.

Losses in the quarter include the Alberta, Canada wildfires, which Morgan Stanley estimates will cost in the region of $3 billion to $7 billion, with reinsurance firms expected to assume between $2 billion and $5 billion of the loss.

“Alberta fires could have significant impact on global reinsurers as primary carriers in Canada typically have very low retention,” explains Morgan Stanley.

Other events in the quarter of note, says Morgan Stanley, include the Texas hailstorms and flooding ($2bn to $3bn), earthquakes in Japan and Ecuador ($3bn to $7bn), and flooding across parts of Europe ($2.2bn to $2.7bn).

Despite a significant volume of losses in the second-quarter, Morgan Stanley analysts don’t expect this to result in a turn in pricing, predicting further declines in the coming months and stressing that “every 5% pricing decline could still impact ROE by more than 2pts.”

The firm did stress the potential for further losses in the coming months for reinsurers should there be any activity in the Atlantic hurricane season, which, following the continued rise of ILS in the global catastrophe reinsurance sector, would likely result in further losses here, also.

Morgan Stanley’s analysis sends a similar message as previous commentary on the outlook for the sector, that despite a rise in losses in the first-half of 2016, this isn’t significant enough to have any meaningful, positive influence on pricing.

Cumulatively, property catastrophe reinsurance pricing has reduced by 40%+ in the last three years, says Morgan Stanley, and as a result “traditional reinsurers are pulling back as returns approach high-single digit in this volatile line.”

“Alternative capital growth has also slowed as margin deteriorates and the products are yet to be tested by large losses,” continued Morgan Stanley.

Declines have moderated at the most recent renewals, with reinsurers showing discipline and walking away from unattractively priced business, and essentially underwriting for the sake of underwriting.

It could require a record-breaking hurricane loss event to turn pricing in the market, or perhaps an aggregation of significant events, but it’s clear that analysts at Morgan Stanley feel recent events aren’t going to impact the sector and alleviate some of the competition and pressures.

In order to boost returns in the current environment reinsurers have been releasing reserves, some more aggressively than others, and Morgan Stanley predicts that while primary players will rely less on reserves to bolster earnings moving forward, the firm expects “strong reserve releases” from reinsurers to continue.

Only the coming months will tell if full-year catastrophe losses follow the trend of the opening months of 2016 and are above the recent average, and whether this will be enough to turn the market, and how reinsurers and ILS players react.

While for some, and likely those that have remained disciplined and innovative in the softening landscape, a return to more normalised or an above average series of losses will provide opportunities.

For those that perhaps aggressively released reserves too often, or fall subject to an aggregation of losses or overexposure via ill-disciplined underwriting, when the market does start to turn losses could begin to mount very quickly.

With further rate reductions expected through 2016, and likely into next year absent a market turning event, the pressures on reinsurers to remain relevant, innovate and ultimately navigate the testing time remains intense, and it’s expected only some will survive the current market environment.