Buyers’ market to persist in uncertain reinsurance landscape: Morgan Stanley

Challenging reinsurance market trends witnessed throughout 2015 are expected to continue heading into the New Year, with the impact of alternative reinsurance capital, M&A, and reserving adding further uncertainty.

Analysts at Morgan Stanley have discussed the well-documented trends witnessed in the global reinsurance market throughout 2015, warning that much of the same is to be expected during 2016.

Despite their view that “pressures on reinsurers will be somewhat lower next year,” Morgan Stanley stresses that reinsurance is still very much a buyers’ market, as competition, ample capacity, and a lack of losses continues to drive, and hold rates down.

“Pricing trends continue to be dampened by high levels of competition. In reinsurance, we think that the rate of decline is slowing in property, but casualty pricing is beginning to see some pressure,” says Morgan Stanley.

With losses low and capital from traditional and alternative sources in abundance, competition in the global reinsurance industry has been intense in recent times.

And as highlighted by Morgan Stanley, while the flow of third-party reinsurance capital into the property arena may have slowed somewhat, helping to minimise declines, and even stabilise rates in some regions, its increasing entry into casualty business signals greater pressure on pricing in this area.

While the flow of alternative reinsurance capital providers remains strong and their appetite for reinsurance risk persists, it’s likely to continue its shift from the very competitive property lines to the less competitive, but also less understood exposures like casualty.

“We have seen some alternative capital structures in casualty, but we think it is unlikely to increase materially or quickly due to the long tail nature of this line,” said Morgan Stanley.

For the capital providers themselves, while this points to potentially higher, and more stable returns than seen in the property sector in recent months, a lack of adequate modelling, and a lack of risk knowledge could lead to greater, and unrealised exposures, something that is even more dangerous when market conditions are tough.

One of the ways reinsurers have been trying to offset declines in underwriting profits in a challenging market is through reserve releases, an area the analysts at Morgan Stanley have some concerns with.

“We would highlight that we do not think reserve releases will come to an abrupt end, but that the high extent of reserve releases seems unsustainable to us and we could see a gradual decline,” said Morgan Stanley.

With the benign loss period continuing reinsurers’ reserve buffers are beginning to diminish, particularly in the U.S., notes Morgan Stanley.

Companies have struggled to generate desirable returns on their underwriting business and, while masking this somewhat via prudent reserve releasing is common practice, the lack of large losses means firms aren’t able to replenish their reserves as they would perhaps like to, something that can really come back to bite when the next large event happens.

In fact, Morgan Stanley underlines that when “normalising for the better than expected natural catastrophes and positive prior year developments, non-life re combined ratios have been moving closer to 100%.”

Looking to January 1st renewals and the analysts at Morgan Stanley expect reinsurance pricing to remain soft, with further, albeit moderated rate declines expected.

Somewhat contributing to the moderated rate declines is the slowing entry of alternative reinsurance capital in recent times.

“On the supply side, alternative capital growth has begun to slow down (in property reinsurance) as returns have begun to reach a level where investors are pulling back,” explains Morgan Stanley.

However, the firm stress that the competition from insurance-linked securities (ILS) players, along with Solvency II implementation, and a desire to grow in emerging markets, will be a driver of continued merger and acquisition (M&A) activity during 2016.

Although the firm does predict the rate of consolidation to slow from the levels seen in 2015, owing to a shrinking pool of potential M&A participants, and the rising value of deals seen in recent months.

Another thing to look out for at the upcoming key renewals, notes Morgan Stanley, is further weakening of terms and conditions, “such as widening hours clauses and inclusion of cyber policies.”

This is another tool reinsurers have exercised in recent, tough times, seeking to beat the competition by essentially offering more coverage for your money. Again, this practice has the potential to come back and bite, as a result of overexposure and unrealised risk accumulations.