The effects felt by some traditional reinsurers from accelerating convergence, between reinsurance and capital market backed reinsurance alternatives, are likely to continue according to a report from Bernstein Research. It forecasts reinsurance convergence and third-party capital will challenge the sectors incumbents for many renewals to come.
Bernstein Research, the research brand of Wall Street analyst firm Sanford C. Bernstein, analysts believe that we are currently witnessing the end of an era for property catastrophe insurance and reinsurance. Their remarks suggest that we are moving into a new market dynamic, where the status quo between traditional and alternative players and capital sources has changed, and that this dynamic is going to continue to evolve for some years to come.
The analysts recognise that the property catastrophe reinsurance sector has just undergone one of its more difficult renewal seasons and said that the last quarter has seen a key milestone, as capital markets backed reinsurance alternatives, which were once viewed as expensive and exotic, have now become routine, low-cost alternatives to traditional protections.
The report says that for traditional reinsurers, the results from the mid-year renewals appear something of a rout, and should be seen as confirmation of a structural change within the market which it believes is likely to challenge sector incumbents for many renewals to come.
The analysts, led by senior Bernstein analyst Josh Stirling, said that with capital markets convergence over 15 years in the making, the last twelve months has seen dramatic progress in this sector. Capital market entrants to the reinsurance space now have access to greater supply, better technology, and we’re now seeing the capital markets setting the terms of trade. These unrated players have some advantages over traditional reinsurers, not least the absence of rating agency capital standards, giving them a much cheaper cost of capital.
Traditional incumbents in the reinsurance space, target returns on equity in the mid-teens, where as alternative reinsurance capital providers such as pension funds can deploy capital for half of that, as to them the return from ILS is all alpha, the report says. The report also says that it has zero correlation, which is not quite true as our regular readers will appreciate, but the low-correlated nature of ILS and reinsurance is indeed a real draw for investors.
The analysts say that they have seen dramatic inroads in this market in the last year, as convergence players apply creative energy to grow the market and new entrants, and increasing capital inflows, helped to drive pricing lower. This price drop has moved from ILS products to traditional property catastrophe reinsurance lines of business, creating a real pricing impact for incumbents at the mid-year renewals.
The Bernstein analysts say that they still like property catastrophe for equity investors, but they don’t see the trends changing and believe this is going to result in declining margins across the sector. They expect investor appetite and supply of capital to far outstrip demand for reinsurance, meaning that declining property catastrophe pricing is likely to continue through the coming renewals and beyond.
The analysts say that incumbents such as RenaissanceRe face clear headwinds to their core business margins going forwards and that while RenRe is still their preferred reinsurance player stock they have reduced its rating to market-perform. They cite RenRe’s ten years plus managing third-party capital as key to its ability to be innovative and select the best risks for itself and for others capital and RenRe’s strategy leads them to believe the stock is fairly priced still.
However the Bernstein analysts do believe that the headwinds that established property catastrophe reinsurance market leaders, like RenRe, face are not going away any time soon as reinsurance and capital markets convergence continues apace.
Finally, the analysts note that one of the key issues to watch for is whether third-party and capital markets reinsurance capacity begins to make inroads into other lines of reinsurance and insurance business. The analysts wrote:
While we doubt capital markets players have an appetite for more traditional insurance risks, capital is fungible, and we’ll be watching to see if the impact of this new capacity is ultimately transmitted outside of this small niche by diversified multi-line reinsurers who may seek to compensate for margin pressures in high margin property catastrophe by getting aggressive, cutting prices and seeking growth in other lines.
Our regular readers will know that we fully expect that the capital markets participation in reinsurance will expand outside of property catastrophe once the market is right for this. In fact there are already a number of asset managers deploying third-party capital into privately transacted casualty and other lines of business. Right now this is a very small piece of the convergence market but investor appetite points to a need for more diversification outside of property CAT and many in the sector expect this to be the next challenge for traditional market incumbents.
The report makes for more interesting reading and reinforces the position taken by almost every analyst firm we’ve spoken to or read a report from this year. The trends currently affecting the traditional reinsurance market, due to capital market investor interest in the space, are not going away any time soon and could continue to impact the reinsurance market for many years to come.
If you’d like a copy of the report please contact Bernstein Research via its website.