Alternative reinsurance capital signals structural pricing change: Morgan Stanley

The challenges borne by the traditional reinsurance, and increasingly primary markets from the expanding pool of alternative capital entering the space, signals a structural change in the reinsurance pricing cycle, according to analysts at Morgan Stanley.

Examining the current reinsurance and insurance-linked securities (ILS) trend, including catastrophe bonds, cat bond lite deals, and the rise of collateralized reinsurance, analysts at Morgan Stanley note that despite a deceleration in rate declines during mid-year renewals, the reinsurance pricing cycle is vulnerable to the impacts of alternative reinsurance capital.

“We still believe that alternative capital presents a structural change in the reinsurance pricing cycle and that in the future we will not see clear peaks and troughs, not only in U.S. nat cat but potentially other lines,” says the report.

A combination of prolonged, benign catastrophe losses, increased competition, and a persistent influx of alternative and traditional reinsurance capacity has pressured reinsurance pricing for some time now, with reports suggesting a decline of more than 30% in the last two years alone.

The most significant declines in recent months have been witnessed in the natural catastrophe reinsurance sector, but increasingly primary business lines are beginning to feel the impacts of a softening reinsurance landscape.

However, the recent June/July renewal season saw price declines moderate in some areas, with nat cat pricing down 5-7%, compared with -15% for the same period last year.

Risk spreads on US wind cat bonds have stabilised in 2015 - Source: Morgan Stanley

Several industry experts and analysts noted recently that much of the deceleration of price declines witnessed during mid-year renewals came from an increase in demand during the period, with analysts at Macquarie advising that without a continuation of increased demand, pressures on pricing would likely remain into 2016.

Discussions of a structural change in the reinsurance pricing cycle have been circulating the industry for some time now, with Goldman Sachs, among others, stating earlier this year that while reinsurance pricing will stabilise, this will likely be at a structurally lower level than before.

Similarly, analysts at Credit Suisse noted the structurally lower cost of reinsurance capital, highlighting this as an opportunity for property & casualty (P&C) insurers to access innovative business models and structures.

Morgan Stanley state that while cat bond spreads reached new lows in 2014, owing to the flood of alternative reinsurance capital, apparent stabilisation during the first six months of 2015 suggests that for the protection buyers, “it is no longer as cheap as it was to use alternative capital as a source of insurance.”

Risk spreads in the secondary market stabilised or rose in 2Q, with US wind spreads rising - Source: Morgan Stanley

Furthermore, utilising data from the Artemis Deal Directory, the report reveals that during Q2 the majority of cat bonds priced at the mid-point of guidance or above it, implying “this is a source of some relief for the reinsurers which have competed away not just in pricing, but offering wider terms and conditions that include more perils or allow more time for aggregating losses.”

Regardless of any stabilisation in cat bond spreads and reinsurance pricing during the first-half of the year, and any resulting lessened pressures, a hike in the use of other alternative capital structures, such as cat bond lite deals and collateralized reinsurance, “will put significant pressure on the traditional reinsurance industry,” advised Morgan Stanley.

The image below shows just how much the use of collateralized reinsurance, ILW’s and sidecars has increased in recent years, with the cat bond asset class now representing less than 50% of the global alternative capital market, which the report puts at $65 billion.

The alternative capital and ILS market grew by 3% in 1Q15 - Source: Morgan Stanley

As a result of the structural change to the reinsurance pricing cycle, exacerbated and driven by alternative capital, a lack of catastrophe loss events and intensified competition, analysts at Morgan Stanley underline the importance of a service-led model.

“We see the relative beneficiaries as the reinsurers which can offer a suite of services and products to clients, as well as being able to insure more complex risks that cannot be captured by a model,” advised Morgan Stanley.