Decoupling of ILS and traditional reinsurance pricing to keep pressure on rates

At the recent July 1st renewals, reinsurance market pricing continued to be influenced by the influx of third-party reinsurance capital which has poured into the market from institutional and capital market investors, said Guy Carpenter in a report released today. Without significant catastrophe losses through the rest of the year, the pressure on reinsurance rates looks set to continue.

Despite the first-half of 2013 seeing insured catastrophe losses in the region of $20 billion, which is above the ten-year average for the period, reinsurance market rates-on-line have continued to experience pressure due to over-capitalisation in the sector largely created by the third-party capital influx.

Alongside the influx of capital, robust activity in the catastrophe bond, sidecar and collateralized reinsurance markets so far this year has caused ILS pricing to ‘decouple’ from traditional reinsurance pricing for the first time, said Guy Carpenter. This means that the pricing on cat bonds and ILS type collateralized contracts has stopped being influenced by traditional reinsurance pricing, instead becoming influenced by issues such as cost-of-capital, investor risk appetite and supply side dynamics.

The decoupling of ILS and traditional reinsurance pricing has exerted further pressure on traditional reinsurance rates and forced reinsurers onto the defensive in order to secure volumes of business necessary at the renewals. Guy Carpenter now puts the amount of convergence capital in the reinsurance market at $45 billion, or approximately 14% of global property catastrophe reinsurance limit.

The amount of excess capital in the reinsurance market has helped to mitigate the impact of catastrophe loss events such as the U.S. mid-west tornadoes, the recent severe flooding in Europe, India and Canada during the second quarter of the year, according to Guy Carpenter.

“At July 1, we saw continued significant decreases in U.S. property catastrophe program pricing. Although the impact of convergence was less dramatic elsewhere, general downward pressure on rates was observed for property business in several other regions and across some casualty lines,” commented David Flandro, Global Head of Business Intelligence at Guy Carpenter.

The pressure on reinsurance pricing is set to continue through the rest of the year and into the next key market renewals in January 2014. Most observers expect rates to experience another fall at 1/1 unless we see some market moving catastrophe events during the rest of this year.

At the same time, it is expected that inflows of capital from third-party investors into reinsurance will pick up again towards the end of the year and catastrophe bond issuance could reach record levels in 2013. Further influxes of capital will force collateralized reinsurance managers to deploy capital at competitive rates again and we could see the convergence markets percentage of global prop-cat reinsurance limit increase further by the end of the January renewals.

David Flandro continued; “Without further significant catastrophe losses in the remainder of 2013, we expect that this downward pricing trend will likely continue through the remainder of the year and into the January 1, 2014 renewals.”

The 2013 reinsurance renewal season has seen a shift in the patterns and trends to which the market had become accustomed, with pricing being moved not just by the amount of capital but by its cost, risk appetite and motivations. How this capital behaves in the market is important and the cost of this cheaper reinsurance capital is an increasingly important factor and the main reason that traditional reinsurers have been forced to reduce pricing and improve renewal terms (in many cases).

“For the third consecutive year, we’ve seen a significant shift in market conditions during the second half of the renewal season,” commented Lara Mowery, Global Head of Property Specialty at Guy Carpenter. “This behavior is contrary to the market’s historical precedent, as the factors that typically impact the mid-year renewals are normally driven by those already present in January. As seen in this year’s July renewals, the excess capital in the market, and more importantly, the behavior of that capital, has encouraged a dramatic shift that triggered downward pricing in the traditional market in order to remain competitive.”

On U.S. property catastrophe reinsurance program renewals pricing pressure continued and some of the largest decreases in pricing seen so far this year were witnessed at July 1st, according to Guy Carpenter. Loss impacted programs generally saw less pricing pressure, although still saw moderate decreases in renewal pricing. Property per-risk reinsurance pricing has also begun to feel rate pressure in the U.S.

Latin American and Caribbean property renewals have seen some price reductions at July 1st, due to a high level and diversity of reinsurer offerings. Argentina was the exception due to significant flood losses in April and also regulatory issues which reduce the breadth of reinsurance offerings.

Property retrocession reinsurance renewals have seen significant rate reductions, according to Guy Carpenter, with the largest risk-adjusted reductions on growing portfolios. Further pressure on retro pricing is expected through the rest of the year if there are no major loss events.

For industry loss warranties (ILWs) while aggressive pricing was the feature of the start of the year, causing terms on ILW contracts to fall, there has been signs of increased activity in the ILW market as the peak U.S. hurricane season approached.

For the catastrophe bond market, issuance of property-catastrophe cat bonds $4.2 billion by July, with risk capital outstanding reaching record, all time high levels of around $16 billion. Cat bond books were marked by over-subscription, said Guy Carpenter, as well as increased risk profiles both in terms of the underlying books of business and the cat bond triggers.

Casualty reinsurance lines of business saw generally improved or flat pricing at the renewals, with the exception of the workers compensation reinsurance market which shows signs of becoming soft. The life, accident and health reinsurance renewals showed increasing competition around the market, some of which is a result of reinsurers looking to grow their books of business as a reaction to decreasing premiums in other reinsurance lines.

Overall the outlook for the rest of the year will be one of further price and rate reductions across U.S. property catastrophe reinsurance, with some of that pricing pressure beginning to spill into other regions and lines of business. Increasing third-party capital in the reinsurance space will exacerbate these rate reductions, but the high levels of capitalisation in traditional reinsurers will also play a part while the market remains free of major catastrophe loss events.

So for traditional reinsurers it looks like a case of ‘more of the same’ as we move towards January. For the ILS and collateralized market, backed by alternative reinsurance capital from third-party investors, some strategies will now begin to move towards ensuring some level of rate stabilisation occurs before record low pricing eats too far into managers profits.

You can read the full press release from Guy Carpenter, with more insight about how other lines of reinsurance business handled the renewals, here.