Pressure from “cyclical softness” in the global reinsurance market will increase as alternative or third-party sources of reinsurance capital expand their horizons, but evidence suggests they’re not behaving recklessly according to analysts at KBW.
Analysts at Keefe, Bruyette & Woods, led by Meyer Shields and William Hawkins, came to this conclusion after holding a conference call featuring a number of leading figures from the reinsurance and insurance-linked securities market.
Following the call the KBW analysts said that they were now “a little more pessimistic about the reinsurance industry’s medium-term outlook.” Despite some signs that catastrophe bond pricing may be approaching a floor, the analysts said they see no sign of a let-up in the softening across reinsurance rates and lines of business.
“Most reinsurance lines rates are under both cyclical and secular pressure, with centralized reinsurance purchasing and broadening reinsurance terms and conditions likely to persist for the next several years,” the analysts explained.
It’s not all bad news for the market as a whole though, KBW noted, with anecdotal signs of catastrophe bond yields slightly widening year over year and capital market investors becoming very price sensitive. They provide an example of a recent cat bond issuance, which when the marketers tried to lower the yields only slightly went from being three times oversubscribed to being undersubscribed, as investors demonstrated they are not prepared to take on risk at any price.
The KBW analysts conclude from these examples that while capital markets investors have a lower return hurdle than traditional reinsurers “they’re not behaving recklessly.” An important point to note, because some would level claims of recklessness at all ILS investors, as clearly the sophisticated ILS managers and pension funds know where their risk appetite and cost-of-capital lies.
Also positively, there is some evidence of increasing reinsurance spend, following a few years of reductions, KBW said. Some cedents are evaluating larger reinsurance spends, likely to take advantage of record low pricing and availability to risk capital.
Florida cedents are likely to increasingly look to replace portions of their Florida Hurricane Catastrophe Fund (FHCF) coverage with private market reinsurance covers, KBW explains, which could amount to as much as 25% of $17 billion. The FHCF could also seek to buy reinsurance protection, KBW notes. All of this could go some way to soaking up some of the excess capital in the reinsurance marketplace.
However, reinsurance pricing is soft and the softening is set to continue, the analysts explain, with no relief expected while capital is abundant and losses remain light. And this softness could become even more apparent in other regions of the U.S. market and lines of global reinsurance business as alternative capital looks to broaden its reach and finds new ways to tap into the returns of insurance and reinsurance business.
The analysts explained; “This cyclical softness could come under even more pressure as alternative capital further saturates the Florida market and spreads into property catastrophe risks beyond the Southeastern U.S., followed by a likely sequential flow into other lines of business ranging from commercial flood or aviation (which we see as broadly similar to hurricane and earthquake in its short tail and “modelability”) to catastrophe-related business interruption risks, and then to more complex and still-developing casualty reinsurance vehicles.”
There is plenty of evidence that alternative capital provides and insurance-linked securities (ILS) managers are becoming increasingly capable of broadening their reach into ever deeper areas of the insurance and reinsurance markets.
Trends such as directly accessing insurance risks via fronting carriers look set to gain incremental business for ILS players, while also reducing the flow of risk into traditional reinsurance markets. This will allow ILS players to continue to grow, acquire new business, at the cost of traditional players. Also for the top-tier ILS fund managers, their size now allows them to be regular participants in the world’s largest reinsurance programmes and smaller traditional players are the one’s suffering that get pushed out.
Continued development of ILS as an asset class, with greater ability to diversify within it, looks set to continue to attract new investor capital to the space as well. After a period of consolidation, in recent months a number of ILS managers have begun again to attract new capital and investors, as they find their position and emphasised profile in the reinsurance market now allowing them to deploy more capacity.
This increased reach and perhaps new-found expansiveness of the ILS market is set to continue to apply pressure on traditional reinsurers. With pricing indications suggesting more rate declines in Japan and at other April reinsurance renewals, as well as pricing suggesting more year-on-year rate declines in June and July, the situation looks set to get no easier.
KBW’s analysts also raise the ongoing concern about terms and conditions expansion within reinsurance contracts, saying that broadening of terms to relax the hours clause, provide multi-year contracts, include clash covers or cyber risk and even longer duration catastrophe bonds, “appears particularly risky, since it limits the predictive value of past premium and loss experience.”
As we’ve written before, taking on significantly more risk and uncertainty through broadened terms and conditions while rates are so low is particularly risky, but it will take events, perhaps only attritional, for this to show up who has perhaps not been as disciplined as they should.
As a result of ongoing and continued pressure, and the expanding reach of ILS and alternative capital, KBW’s analysts said that they expect reinsurance market consolidation to continue.
But joining the discussion that size isn’t everything, the analysts explain “size and agility don’t coincide automatically, and traditional factors like underwriting discipline are also likely to distinguish better and worse underwriters.”
Finally the analysts note that the continued, and anecdotally showing signs of increasing, alternative capital inflows suggest that retrocessional coverage should get increasingly more affordable.
So it’s not all bad for the analysts equity investing clients, “despite the expectations of intensifying competition, we think there are still a few opportunities for investors.” However those opportunities are likely to become fewer as market pressure and consolidation continues and as returns on equity naturally drop in this environment how long equity investors will remain attracted to the space will come into question.