Differing, or non-homogenous, views on underwriting profit margin are driving the competition in reinsurance markets, as markets continue to test for the optimal, lowest profit margin above loss costs, according to Platinum’s Michael Price.
Platinum Underwriters Holdings, the Bermuda based provider of global property, casualty and finite risk reinsurance coverage, CEO and President Michael Price said that he believes that the reinsurance market will see further declines in pricing as participants search for their base-line appetite for profit margins for assuming risk.
Speaking during the Platinum Q2 2014 earnings call yesterday, Price acknowledged that the mid-year reinsurance underwriting season reflected the deteriorating conditions across all lines of business. “Once again,” Price commented, “It proves challenging to find attractively priced reinsurance opportunities.”
Platinum expects to see further price reductions in property catastrophe reinsurance business, Price explained, as well as continued downward pressure on risk-adjusted profits in its casualty lines of business as well. Absent a major catastrophe loss or capital markets event, further pressure is expected on overall rate adequacy, leading Platinum to focus on maintaining a larger position in more profitable markets while letting less profitable business go.
Price explained that capital management remains an option for Platinum, with the firm having the ability and financial flexibility to expand its underwriting, if market conditions looked more attractive, return more capital or to hold riskier assets to boost its returns.
One way Platinum has used current reinsurance market conditions to its benefit is in its own protection buying. Platinum purchased retrocessional reinsurance protection at the mid-year renewals, taking advantage of pricing and market conditions to offload some more of its peak exposures. The firm purchased a $50m property catastrophe aggregate cover, protecting its portfolio against higher return period events for all natural perils in the U.S., as well as Caribbean hurricanes, Japanese typhoons and Canadian earthquakes.
Platinum continues to try to ward off some of the impacts of the soft reinsurance market by attempting to boost its asset side returns. Earlier this year it emerged that Platinum would look to adopt a more aggressive investment strategy, to try to earn a better return from its investable assets.
During the Q2 call yesterday Price explained that this strategy was still its plan for investment returns, saying; “We’ve continued to explore higher risk, higher return investment strategies and anticipate allocating funds to this purpose by year-end.”
Price said that in general the return on equity (ROE) of Platinum’s book of business is trending down over the last few quarters. Before, he explained, Platinum had a 10% ROE target below which it started to shed business. However, in the current market environment Platinum has had to move below this target, holding more business on its books in the high single digit return range, something Price stressed it would not have done historically.
That is interesting as it is a sign that reinsurers are accepting greater levels of risk due to the high competition in the market. If you consider that pricing is down as well, Price himself said that as much as 30% of the margin of some business is now gone, as well as the fact the firm is accepting lower ROE business it certainly gives the impression that the book could also be riskier. Time will tell.
Price said that it is expected that the combined ratio will trend up a bit, for the market and Platinum. He said on the industries and Platinum’s combined ratios; “Looking ahead, it’s unlikely they can remain static, even in our portfolio, since we are no longer actively shrinking the book and we’re now limited to just using the mix change tool for managing combined ratio.”
Also of note is that there is less excess of loss premium and more proportional, which will also result in an increase to the combined ratio. Price explained; “Proportional is going to carry a significantly higher combined ratio than excess-of-loss will on an expected basis. So, as we write more proportional business, we would expect the combined ratios of the property and marine segment to rise.”
Higher combined ratios, lower ROE underwriting, more price declines. It’s easy to see why some reinsurers are concerned about the outlook right now.
One interesting element of the current market environment is increasing ceding conditions in a soft market when insurers are not ceding as much business out, despite the attractive reinsurance pricing. This can bring its own challenges as reinsurers look to maintain a foothold in key programmes and accounts. Price said this was a sign of insurers leveraging reinsurance as an attractively priced capital management tool.
Price said that he does not believe the stories that the market is testing the bottom for price declines yet. He said that while recent rate declines have removed as much as 30% of the expected profit from reinsurance business there is still room for more that margin to be eroded and some players will likely push even further down on pricing in some regions and lines.
“The business that’s being bound today still has expected profits embedded within it and, obviously, there are market participants that view that business as being attractive, whether it’s in absolute terms or relative to their other opportunities,” Price explained.
So Price expects further downward pressure on reinsurance pricing, saying that of course these is a level that pricing should not go below, where capacity is assumed at or below loss costs, but players in reinsurance, both traditional and alternative, are testing for the optimal level of return above loss costs.
“The issue that’s being debated and resolved in the broader marketplace is what is the appropriate expected margin on top of expected loss cost? And that’s complicated. Different parties have different views of loss cost depending on the model that you use and whether you make adjustments to it and whether you’re applying it correctly and how accurate it is,” Price commented.
Different companies have different views of how much profit needs to be embedded in the model, for different perils and risks. In Price’s view, this is driving competition in the reinsurance market, this ability to underwrite at different profit margins or costs-of-capital.
This dynamic is not going away, Price said, it cannot go away as there is not one perfect model. So as a result, while these differing and non-homogenous views on underwriting profit margins and cost-of-capital exist, Price expects further downward pricing pressure on catastrophe exposed business.
However, Price does not expect a continuation of double-digit rate declines at upcoming renewals. While reinsurance renewals may see further declines the decrease does have to slow down at some point, he said.
Price’s comments are interesting as they clearly show another reason that ILS is considered a low-cost alternative to traditional reinsurance capital. Testing for the floor on margins is something ILS has done well this year and the fact that some catastrophe bonds appear to be nearing that margin floor, combined with Price’s comments, might suggest that future price declines are more likely to be driven by the traditional market than ILS.
It’s worth reading our article from earlier today, in case you missed it, which also discusses the competition in the reinsurance market and the fact that much of it is driven by the traditional reinsurers, rather than the alternative players and ILS managers.