Differing grades of reinsurance “culling” among cedants signals a growing divergence between Tier 1 and Tier 2 reinsurers as strategic partnerships and track record trump capacity, according to Standard & Poor’s (S&P).
Reinsurance industry commentary from insurance and reinsurance ratings agency S&P, claims that the divide between Tiers 1 and 2 reinsurers is broadening, as cedants fail to view companies equally.
“Cedants prefer reinsurers that have claims-paying track record rather than those that are pure sources of capacity. Tier 1 reinsurers remain more relevant to cedants because of their long-standing relationships, value-added services, and complex risks,” explains S&P.
With the prolonged softening reinsurance landscape predicted to continue into 2016, relevance and scale will likely remain a top priority for companies as they seek to navigate unfavourable market conditions, resulting in the neglect of smaller, mono-line firms and further widening the gap between the reinsurance market tiers.
Larger, Tier 1 reinsurers, S&P notes, provide cedants with wide-ranging portfolios and typically house a larger reinsurance panel, which favours some cedants. Contrast to this, certain cedants opt for efficiency gains and prefer a reduced reinsurance panel size, claims S&P.
But, “Despite diverging views regarding optimal reinsurance panel sizes, one thing is for certain: Cedants tend to view Tier 1 reinsurers as strategic partners,” says S&P.
This point echoes the views earlier of S&P regarding a proven-track record over capacity, and is a trend driven and exacerbated by the continued softening reinsurance sector, where major reinsurers are better equipped and placed to adapt to the changing market environment and still turn a profit. Naturally, this is attractive to cedants and even more so at a time when yields are pressured and competition is high.
S&P continues; “Tier 1 reinsurers have leveraged their status in the eyes of cedants by leading reinsurance programs and repackaging risks. The market will always need reinsurance program leaders to establish underwriting blueprints, even though third-party capital is beginning to participate in a form-following function.”
Regarding third-party or alternative reinsurance capital S&P expands, noting that the balance between Tiers 1 and 2 reinsurers won’t lean towards third-party capital players, “because these players’ commitment to the marketplace is confined to commoditized products (i.e., cat risk) for now, and their future claims-paying capabilities are less certain.”
The final point S&P raises is one that’s existed since the volume of third-party capital and structures began to gain mass in the global reinsurance market.
Since the presence of alternative capital has really started to swell and impact traditional reinsurance and primary business lines, there has been a lack of major catastrophes, meaning that’s it’s still largely an untested model in terms of how the capacity and its providers will react following a large loss event.
That being said, it is widely believed among rating agencies, analysts and experts that the glut of reinsurance capacity from alternative sources will remain after an event, and that the market won’t struggle to recapitalize.
Furthermore, while insurance-linked securities (ILS), cat bonds, sidecars and other alternative risk transfer solutions are mainly focused on easy to model, commoditized risks, most notably cat risks, as the acceptance of third-party capital structures grows so to will its expansion in to other business lines, such as casualty for example.
The ratings agency also highlights that Tier 1 reinsurers are equipped to issue private placements and their strong balance sheets enables them to offer adverse development coverage (ADC) treaties that are exclusive to cedants.
“ADC placements by tier 1 reinsurers are attractive to cedants because they are trading high reserving risk for low credit risk, providing a form of capital relief,” explains S&P.
Tier 1 firms are able to secure higher limits and more aggressive coverage terms in respect of private placements claims S&P, which they then repackage and retrocede to Tier 2 reinsurers and third-party capital structures, such as sidecars, cat bonds and collateralized reinsurance.
The attraction of larger, Tier 1 reinsurers is clear and will likely grow further as the softening reinsurance market persists. As the gap widens Tier 2 companies will increasingly search for scale and relevance, a sign that the re/insurance merger and acquisition (M&A) trend is set to persist also.
With competition rife and the record levels of capacity, from traditional and alternative sources intensifying, continuing to stress the market and subsequently reinsurance pricing, cedants will increasingly look to long-term, strategic, and proven players, signalling further tough times ahead for Tier 2 reinsurers.