As global reinsurance prices continue to soften, underwriters in the space are faced with pressures leading to a search for scale and diversification. But analysts at Bernstein have warned that firms that are highly diversified could ultimately prolong pricing pressures.
Typically, analysis and industry insight on the softening reinsurance sector has underlined the benefits of a diversified risk portfolio, utilising the returns of differing risks to maintain sustainable profitability as well as hedge exposures against one another.
However, analysts at portfolio management and investment research firm Bernstein, in a recent report, note the possible risks associated with firms that aren’t solely a reinsurer, or that utilise a highly diversified business mix, as a result of the softening re/insurance landscape.
As an example Bernstein draws on XL and its recent acquisition of Catlin, resulting in a new, large insurance and reinsurance entity, XL Catlin.
It’s important to note here that in light of its view surrounding XL, Bernstein’s message could apply to anyone attempting to gain scale through merger & acquisition (M&A) activity, or expansion through hiring new teams, or simply seeking to expand through writing business across more lines of business covering a broader geography.
Bernstein warns, “though XL is not solely a reinsurer, and as a result of their recent acquisition of Catlin, they have many levers to pull to improve margins, the firm’s concentrations in some of the more cyclical markets including reinsurance and specialty in Bermuda and at Lloyds, likely will expose them to continued pricing declines for some time, and balance some of the opportunities for margin expansion created by their consolidation efforts.”
It’s certainly an interesting angle to take on the potential and increasing dangers re/insurers are faced with when seeking greater scale or diversification to battle the tough reinsurance operating environment, but it does make a valid point.
In recent times, as the benign loss activity, heightened competition and ample capacity has continue to drive and exacerbate the softening reinsurance market, resulting in a persistent downward pricing trend, firms have adopted multiple ways of trying to add something new to their underwriting, which could result in them being overexposed.
The abundance of alternative reinsurance capacity that is continuing to enter the space, albeit currently at a reportedly slower pace than previously witnessed, has caused an overspill of capital resulting in reinsurers increasingly entering into longer-tailed lines such as casualty.
Furthermore, should property catastrophe pricing eventually find a bottom the overspill of capacity will likely filter down into more and more business lines, as companies reduce their exposure to short-tail competitive lines, such as property cat, and redeploy capital into markets with more desirable levels of return.
But the message, or warning from Bernstein suggests that firms’ which are exposed to various business lines, from aviation to energy, property cat to casualty and so on, are likely to experience prolonged pricing pressures owing to the fact pressures exist, and are likely to intensify across most business lines, not just property cat reinsurance, for example.
Also, Bernstein notes that beyond exposure to continued pricing pressures, those searching for scale through rapid expansion, M&A, hiring, and so on, risk missing out on opportunities for profit growth created by their initial strengthening efforts, owing to a need to balance multiple operational areas that will likely be experiencing rate pressures at the same time.
Although differing from previous analysis on the potential impact to firms created by the persistent softening market landscape, Bernstein highlights another important element companies should be attentive to when considering expansion, whether organically (which is unlikely in current market conditions) or through consolidation efforts.
Undoubtedly insurers, reinsurers or combinations of the two, like XL Catlin, will have their own views on how best to navigate the tough reinsurance market, and perhaps scale and diversity will prove to be the answer, but only time will tell which approaches are successful and which aren’t.