Alternative capital still a determinant of reinsurer profits: Fitch

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Alternative reinsurance capital and insurance-linked securities (ILS) are still seen as key determinants of reinsurer profits and success, a new report from Fitch Ratings suggests.

fitch-ratings-logoExplaining that reinsurance market mergers and acquisitions may be limited over the next year or so, Fitch Ratings highlights investor concern as a key reason.

Here the rating agency isn’t talking about ILS investors, rather it is referring to the kind of private and public equity investors that take big reinsurers private, or aggregate companies to merge together.

The reason for this investor reticence is said to be “macroeconomic risks and heightened catastrophe losses linked to climate change,” according to Fitch.

The latter, of course, has also been a determinant of alternative capital’s interest in insurance risk over the last year or so and is likely to be increasingly an important factor for investor decision-making.

The rating agency is a little gloomy over the prospects for M&A in reinsurance, which might disappoint anyone looking for that big exit opportunity right now.

“We expect reinsurers to prioritise pricing, risk management and organic growth rather than M&A as they contend with the implications of the economic slowdown, high inflation and volatile financial markets,” rating agency reported.

Adding that, “Even if the reinsurance market hardens enough for higher premium rates to generate significantly better profitability, we do not expect a wave of interest in acquiring reinsurers in the near term.”

What could make reinsurers more appealing again, higher pricing and increased profits, it seems.

Fitch Ratings said, “For traditional reinsurers, opportunities to increase pricing and improve profitability could develop if rising interest rates lead to lower supply of alternative capital to the reinsurance market, most of which is through insurance-linked securities (ILS).”

Continuing to explain, “Persistently low interest rates following the global financial crisis drew many new investors to the reinsurance market in search of better returns than were available from financial markets.

“In more recent years, ILS investors have pulled back from the market following several years of above-average catastrophe losses. A continuation of this trend could help to extend the hardening market and would clearly be positive for traditional reinsurers’ profitability.”

Which really means that Fitch’s view on reinsurance hasn’t changed a great deal and it still sees alternative capital as one of the key threats to reinsurers ability to sustain profits and pricing.

Of course, even during the period where the property catastrophe reinsurance market was softening rapidly, say from 2012 through 2017, we saw major traditional reinsurance players become incredibly competitive on price in key catastrophe zones and grow into US risks, just as much as the ILS market had.

It’s probably fairer to say that traditional capital’s appetite for risk and its discipline, is just as much a threat to the ILS market, as alternative capital investor’s are to equity-backed reinsurers.

But Fitch’s comments show that capital remains the key and the efficiency of it even more so, as it is the efficient management, deployment and trading of risk and its matching with capital in the most effective way that should allow firms, on either side, to sustain themselves through a return to softening rates, which seems inevitability at some stage.

The fact the global reinsurance market has not made its business model significantly more efficient could come back to bite it.

As should capital decide insurance risk is “where it’s at” again, having lowered the 30 to 40 cents on the dollar of expense and intermediation costs to a more manageable, or comparable with other industries, 10 to 20 cents, would have served traditional reinsurers well.

Going forwards, as the world becomes increasingly technology-led, capital more fungible, and risk gets easier to break-down and price, as you’d hope will happen, maybe we can transition away from thinking about alternative capital as a key determinant of profit, as reinsurers wield it too, and the main determinant of a reinsurers success and profits should be its own underwriting abilities, business model effectiveness, operational efficiency and ability to attract capital (in all its forms).

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