Discipline determines the credit outcome of soft reinsurance market pricing: KBRA

While softer property catastrophe reinsurance pricing can allow P&C insurers to improve their earnings and strengthen their protection it is the management response that matters, rating agency KBRA has said. As those that use favourable pricing to accelerate growth may realise substantially less credit benefit when catastrophes occur or the market turns again.

The benefits of a soft reinsurance market environment are not automatic for protection buyers, KBRA cautions, and it is management transmission that matters.

Lower priced catastrophe reinsurance cover should not be viewed as a signal that risk has declined and while the market is awash with both traditional and alternative reinsurance capital it’s important P&C insurers maintain their discipline

“Savings used to strengthen protection or retained capital are more credit supportive than savings used to fund aggressive catastrophe-exposed growth, materially higher net retentions, or shareholder distributions,” the rating agency explained.

While the decisive shift in reinsurance pricing and terms is in cedants favour, buyers are urged to remember that their credit profiles can be enhanced by retaining the savings to build capital, or buying additional protection, lowering their net retentions and generally reducing their catastrophe exposure.

“Conversely, much of the benefit can be lost if favorable reinsurance economics encourage aggressive exposure growth, higher retained risk, weaker primary pricing discipline, or increased capital distributions,” KBRA said.

One of the features of soft property catastrophe reinsurance markets has always been a tendency for some to seek out growth.

While reinsurance itself can be a driver of growth, if additional protection is harnessed to free up capital to do more, there has always been a tendency among some reinsurers to grow into a softening market, we saw this back through the mid-2010’s.

While KBRA’s advice is for P&C insurance management teams, it applies to those looking to grow into property cat reinsurance at this time. A prudent approach needs to be taken and exposing more of your capital to risk, while increasingly taking on more inwards business in a market where price and terms may continue to deteriorate can be a risky approach.

KBRA cautions, “The rating impact of the current reinsurance pricing environment is therefore likely to be company-specific rather than a broad sector-wide uplift. For many insurers, lower reinsurance costs should be a modest credit positive through stronger earnings and greater strategic flexibility. A more meaningful positive could emerge where insurers use the market to reduce net catastrophe exposure or materially strengthen capital. Conversely, a softer market can become credit negative if management converts abundant capacity into outsized growth or higher retained risk without commensurate capital support.”

KBRA’s message aligns with one being given by the insurance-linked securities (ILS) market over recent months, that now is a time for discipline and a selective approach to new opportunities, in order to maintain portfolio integrity and performance.

While this message also comes through loud and clear from the reinsurance community, history suggests we will also see some growing more aggressively into the deepening trough of the market.

Whether the industry has learned its lessons, on meaningful new capital raising and deployment into a still softening market remains to be seen of course.

But KBRA’s message is the right one, for all market participants, management decisions and the direction of travel chosen can have meaningful implications for the quality of portfolios and ultimately the credit quality your business comes out the other side of the softening reinsurance market with.

Quality of the portfolio, the protection purchased and the counterparties traded with all matter, making management discipline a key feature of those destined to emerge into the next hardening market best positioned.