Alternative capital resurgence could dampen rate momentum: Fitch

Rating agency Fitch warns that a resurgence of alternative capital is to be expected and that this, alongside the growing traditional reinsurance capital base, could begin to pressure rates and dent ambitions for more prolonged market firming.

After the losses of recent years the expectation for firmer reinsurance and retrocession rates has become increasingly prevalent in the market, with the majority expecting that rate increases will be seen increasingly broadly across the market.

However capital is as ever considered the main threat to this, which Fitch Ratings warns could dampen price momentum much sooner than many would have liked.

It’s a wildcard for the upcoming January reinsurance renewals, where many are hoping to see stronger rate increases than a year ago.

But brokers continue to push for the best possible price for their clients, while at the same time competition continues to hold back price momentum, something that will only become increasingly pronounced the more capital is available in the market.

Demand for reinsurance and retro is still rising in certain spots of the market, which will help to soak up some capacity, but not at a rate that would satisfy a truly resurgent insurance-linked securities (ILS) sector that was firing on all of its fund raising cylinders.

It’s a quandary, as ILS will resurge in time and there is already some evidence of this, as we explained earlier today.

In addition, some are forecasting rising catastrophe bond issuance and demand for cat bond investments as well, which would serve to reduce traditional and collateralized reinsurance limit transacted a little heightening competition there, while making the cat bond market more competitive as well.

Fitch notes that, “Alternative capital providers are a source of reinsurance and risk mitigation competition that limits traditional market growth potential.”

The rating agency believes that ILS capacity and alternative capital in reinsurance “could resurge, if insured catastrophe losses move towards historical norms.”

At the same time there is increasing use of alternative capital, which is stimulating its growth as well as the investor demand side.

“Reinsurers are more sophisticated in using capital markets as part of their own retrocession programs to help manage balance sheet risks,” Fitch explains.

Insurers are increasingly au fait with using alternative capital as well, as part of their reinsurance protection.

All of which is also something that is supporting re/insurers returns, which in turn is helping them to accumulate more capital as well.

This also reduces large insurance and reinsurance firms exposure to major catastrophe loss events and smooths their results, helping to moderate the reinsurance pricing cycle even further.

In addition, “Favourable total investment returns are promoting capital expansion,” Fitch says, which, “Combined with any revival of alternative market underwriting capacity, could dampen pricing momentum in relatively short order.”

It is a tricky balancing act for those seeking rate improvements and as a result, for rates to move meaningfully, a broad market consensus on the need for higher pricing is required.

Which is where we find ourselves today, seemingly with a broad consensus but also still rising capital levels, particularly in the traditional market right now and with ILS likely to resurge in the coming months too.

It all provides further ammunition to discussions that the market cycle is not as it used to be, with price rises being now more local, geographically focused and based on individual cedant loss experience.

Which is of course a healthier place for the rate environment to be in. Unless of course you’re still looking for payback from the broader market, in which case there’s a very good chance of being disappointed no matter how large the losses these days.

The moderating of rate increases by alternative capital is of course a very good thing for ceding clients, as the lower-cost of capital of ILS strategies and investors helps to make reinsurance and retro more affordable.

What’s most important is that rates are covering loss costs, the cost of capital, operational expenses and a margin, in order to sustain profitability for the sector, no matter which side of it you are on.

But, as we’ve said many times before, one underwriters’ view of rates and whether they are covering loss costs and trends is not the same as another’s and views can vary quite wildly, as too do strategies and capital efficiency levels.