Further “material” price declines, or evidence of “disorderly” market competition in reinsurance, could result in the need for negative rating actions as prices are already close to some reinsurers’ cost of capital, Fitch Ratings has warned.
In an update, the ratings agency said that the recent January renewal season demonstrated that the reinsurance market has yet to find its pricing floor and that pricing is now nearing some reinsurers’ cost of capital.
At those low levels Fitch warns that if the market does not moderate its appetite there could be negative rating actions ahead.
“Further material price drops, or disorderly competition in the market, could lead to negative rating actions on P&C reinsurers,” the rating agency explained.
Fitch lists the usual factors that are pressuring the reinsurance market, low catastrophe loss experience, abundant capacity from both traditional and alternative sources. As well the rating agency notes demand factors add to the pressure, with “flat to declining demand for reinsurance as insurance companies retain more risk and centralize reinsurance purchasing.”
One positive that Fitch notes for 2016 and beyond is the implementation of Solvency II, which it says has already “created some added reinsurance demand for capital relief.”
On the property catastrophe reinsurance renewals in January, Fitch cites the broker reports which suggest rate declines of -3% to -8% on loss free U.S. accounts and -5% to -15% on international accounts.
Further declines are likely, the rating agency notes of property catastrophe renewals to come, saying that “Absent a significant loss event that reduces reinsurance capital, pricing is unlikely to turn upward.”
Meanwhile, casualty reinsurance renewals saw rates decline by -5% to -10% and Fitch says casualty pricing “will likely continue to fall during the year.”
Casualty is being hit as a diversifier and target for those seeking to avoid price declines in catastrophe risks, the rating agency said. Explaining; “Competition within the casualty sector and specialty lines is driven by current segment profit margins and a desire to diversify in non-catastrophe lines.”
Casualty reinsurance is also not feeling the effects of alternative capital and ILS in the same way as catastrophe risks, at least at this stage.
“The deployment of alternative capital within the casualty sector is not expected to match that of the property market, reflecting reduced investor appetite for longer duration risks that are less easily modelled,” Fitch continued.
Finally, on terms and conditions, Fitch said that terms generally held steady in January, with ceding commissions stable at the mid-to-low 30% level.
However, the rating agency did note some concerns on terms expansion, saying that “multi-year property treaties remain available and it is difficult to fully ascertain changes in underlying treaty terms and conditions.”
Additionally, and perhaps worryingly given the potential for aggregation risks and the clear lack of understanding of this risk in some quarters in the market, Fitch said that cyber risk has been seen to be added to casualty coverage, in some cases.
Fitch seems to be warning that the rating agency feels that the market needs to now find its floor, as it sees risks in some traditional players continuing to underwrite at pricing levels near cost-of-capital.
Add to that further potential for terms and conditions expansion, reinsurers shifting to casualty or primary type risks, perhaps as a reaction to low rates in their traditional lines, as well as the potential for continued bundling of risks such as cyber into other covers, and it’s easy to see where the concerns lie.
If you cannot cover your cost of capital with the rates achievable in the market, but you are also taking on more exposure and aggregation risk, your rating may be at risk, seems to be what Fitch is concerned about.