The main concern cited by reinsurance industry participants in response to a recent survey is current market conditions. The concern centres on soft reinsurance market conditions, created by excess capacity and the influx of ‘new capital’.
The annual ‘Insurance Banana Skins’ survey is back for 2015, with PwC and non-profit think tank the Centre for the Study of Financial Innovation again teaming up to identify what keeps insurance and reinsurance industry participants up at night.
It’s the fifth ‘banana skins’ survey and the 2015 edition highlights that the insurance and reinsurance market is increasingly concerned by regulation, as the top risk for the third year in a row. Macroeconomic risks, interest rate risks and investment performance also feature highly across all respondent groups.
Cyber risk is highlighted as the number one risk for non-life insurance sector participants and number three for reinsurance players, highlighting just how vital it is to get to grips with cyber exposures and the development of new products to insure against them and transfer those risks.
Given its high-profile nature and clear fear that the insurance and reinsurance industry has of cyber risks, it is perhaps a surprise that it still gets mentioned as one of the ‘freebies’ lumped into reinsurance renewals at times to attract business, but that’s another topic.
For the respondents from the reinsurance sector the main concern, topping all others such as cyber, interest rates, catastrophe risks, macro-economic factors and more, is current market conditions typified by the continued build up of excess capacity and continued growth of ‘new capital’ from alternative capital investors.
These concerns focus on the soft market conditions and their expected impact on profitability. Specifically, the survey asked “whether the insurance cycle could result in poor market conditions for an extended period of time.”
It topped the responses for the reinsurance sector, reflecting the fact that this is where the softening of rates has been most apparent and perhaps also reflecting the fact that for insurers this is often seen as good news currently, as it enables them to buy protection more cheaply.
It also ranked number six across respondents from all categories in North America. Again no surprise given the extreme pressure on U.S. property catastrophe reinsurance rates, which is beginning to spread into specialty reinsurance, casualty reinsurance and even commercial lines insurance. However, overall it only ranked thirteenth.
Concerns focused in on the pressure excess capacity is applying and the fact that ‘new capital’ continues to enter the market, thus exacerbating the pressure.
One respondent, a chief financial officer of a non-life insurance company in New Zealand commented; “New competitors and a surplus of capital will support a soft market for some time. Therefore traditional insurers will need to continually look at operational efficiencies.”
Insurance-linked securities (ILS) investors continue to deploy capital into reinsurance instruments, through funds, sidecars and catastrophe bonds. This is adding liquidity to the reinsurance market, at a time when perhaps it needs it least, again ramping up the pressure on players in that space.
A UK based respondent said; “Low returns available on conventional investments have driven the interest for hedge funds and pension funds to invest in catastrophe risk, leading in turn to soft market conditions.”
Chris Wing, Asia Pacific chief financial officer of SCOR in Singapore, said that he believes the growth of ILS capital in reinsurance will tail off eventually; “I think that the rise of ILS will ultimately plateau as soon as a material or series of material losses hit investors and the underlying risk/reward profile is clearer.”
The question of the reinsurance cycle was also raised among respondents answers, with concerns about how the market would react after a prolonged period of softening.
“The danger is that the longer the market spends in the doldrums the worse the storm when the cycle does change,” a broker respondent from the UK said.
But the cycle this time is different, some respondents said, with the entry of ILS and alternative capital a game-changer which has not been seen before. Yes capital has entered the reinsurance market during cycles previously, but never has it been so mobile, quick to deploy, or had such a range of structures and products to be put to work in.
“There are currently factors at play that are new, so it is hard to predict whether the conventional cycle will prevail,” a New Zealand respondent said, while the CEO of a Canadian non-life insurer said; “I think greater sophistication in product pricing and segmentation will contribute to dampening the hard/soft cycles that have plagued this industry.”
“Over- capitalisation is prolonging the soft market to the point of unsustainability,” an executive director at a UK brokerage said.
Interestingly, in the last ‘banana skins’ survey the availability of capital had been cited as the number two concern, due to the impending regulatory changes under Solvency II.
Now, capital availability has dropped to the number sixteen concern overall, reflecting the fact that capital is abundant and in some sectors, particularly in reinsurance, outgrowing opportunities to be put to work.
A respondent from New Zealand commented; “The current oversupply will put real pressure on profitability. It will also create an expectation of supply that may not be matched in the event of a global or significant local event.”
“Lots of capital continues to see the insurance market as attractive, despite those in the market viewing it less favourably,” said a director at a German non-life firm.
The survey report highlights that the emergence of ‘new capital’ and the growth of ILS and non-traditional sources of reinsurance capacity, “will require traditional firms to reinvent themselves to remain relevant.”
One respondent accused traditional insurance and reinsurance players of maintaining a “narcissistic self-deception that the traditional insurance model of risk transfer owns the space.”
Domenico del Re, Director at PwC, told Artemis that it is no surprise that the soft market featured highly in reinsurance sector concerns.
“New capital and excess capacity are not a new threat. The responses show that few expect the market to change any time soon. Re/insurers have now moved on and are thinking how to leverage this excess capacity, and making their business more lean and agile in these market conditions.
“This is not a headline banana skin. It is the new norm, brought about by better modelling technology and risk transfer mechanisms,” del Re explained.
With concerns about market conditions, the soft reinsurance market, excess capacity and ongoing inflows of alternative and ILS capital seemingly leading the way for perceived risks of reinsurance market players, it will be interesting to see how that changes next year.
Will market conditions become more of a concern for primary insurance players next year? Especially if ILS and alternative capital increasingly spills over into that space, or the pressure in reinsurance pushes large, global players to increasingly underwrite primary business?
And will reinsurance sector respondents have come to terms with the fact that market conditions may never be the same again?