The bloodletting in the reinsurance market demonstrates that it is industry capacity that drives the cycle, while the market’s clearing price is now set by the least conservative reinsurance player, according to equity analysts at Alliance Bernstein.
The reinsurance market has shown the true extent of the impact that capital, capacity, competition and the entry of increasing amounts of alternative capital can have on a sector. Equity investors are becoming increasingly cautious on the reinsurance market’s prospects, especially as reinsurers have seemingly been unable to prevent a bloodletting in terms of price erosion.
At important reporting junctures, such as the current Q3 reporting season, equity investors look to reinsurer management so they can gauge just how much pressure the firms are under and to give them confidence in the strategy being adopted. How reinsurers respond to the challenging market is one of the key aspects being watched for by Alliance Bernstein analysts, but even before the majority report their results the analysts are advising investors to avoid reinsurance companies.
Pricing is down, terms and conditions are broadening and the baseline pricing appears to be being set by the reinsurance underwriter that is least conservative, perhaps willing to give away the most. Increasingly the reinsurance market is being priced to levels at which reinsurers cannot cover their cost of capital, say the analysts, so they expect a bifurcation of the market in terms of strategy.
Some reinsurers are set to play defense, which is a strategy of shrinking top lines, managing premiums, leveraging cheap reinsurance and retrocession, reducing their staff headcount and maybe even ultimately selling the company, according to Alliance Bernstein.
The other strategy is to look to grow your way out of the current market environment, by attempting to solve their problems through diversification, growth, hiring new teams, attacking new specialties, moving from short tail to long tail, shifting from writing reinsurance to primary and inevitably looking to consolidate by acquiring one of their more defensive, shrinking peers.
The analysts from Alliance Bernstein note that time will tell whether the returns achieved with the aggressive, growth focused strategy will be commensurate with the risk these firms are now taking. Or whether the pull-back and shrink strategy will allow a reinsurer to continue to maintain profits that investors are happy with, or whether they are pushed to merge even sooner than they would have liked. The coming quarters’ will be telling as each of these strategies begins to be reflected fully in reinsurers’ earnings.
With reinsurance price declines now running into year-on-year territory and pressure on terms and conditions showing no sign of relenting the forward guidance for reinsurers looks gloomy. At the same time Alliance Bernstein highlights that other lines than catastrophe have also become less profitable, with ceding commissions on liability and casualty quota shares up by mid-single digits, allowing cedents to capture the value in those contracts while holding down reinsurers margins.
Alliance Bernstein analysts remain negative on the sector, saying to avoid reinsurance companies as a cohort while not offering any specific opportunities within the sector either. This is aligned with other equity analyst firms who in the main say that while results will likely continue to be acceptable, helped by low levels of losses, as we move into 2015 we may begin to see the length of the soft market beginning to bite.