Have reinsurers lost their pricing power?

Reinsurance pricing is often put down to relatively simplistic factors related to supply (of capital) and demand (for protection). But when it comes to major reinsurers there are other levers, although right now they don’t seem to be pulling them.

Clearly we’re in a market where reinsurance pricing is firming, after consecutive catastrophe loss years, a worsening picture of reserves, fears building over casualty claims inflation and with significant actions taken by major re/insurers to rectify the performance of their books.

All of which is hardening the resolve of underwriters to secure a better return, while also sharpening the pencils of those leading the pricing discussion.

But reinsurers are not able to apply the pricing power they used to command it seems, as analysts from Deutsche Bank suggest that even after suffering losses and with other issues challenging the industry, reinsurers are finding it taking longer and longer to recoup their losses.

The concept of payback is, of course, now a market feature many expect will never return, in the way it was once available.

There was a time when a reinsurance company could hike rates significantly and expect to earn back what it had lost in just a few years, even one year in some extreme cases.

But the reinsurance market of the future is one where accounting for expected loss costs within your pricing is going to be key, to ensure that you’re out in the market with a product (capacity) that is sustainable over the long-term and will be there after losses occur, even when you can’t earn it all back immediately.

It’s been said before, many times here on Artemis, that pricing needs to cover an underwriters loss costs, operational or enterprise expense, cost-of-capital and a margin.

On that basis, as long as loss costs are fully accounted for and adjusted as the view risk, or loss experience, changes, an underwriter can go some way to ensuring that over the long-term its capacity is both reasonably or fairly priced, as well as earning a return.

But still we see areas of the reinsurance market where pricing is severely depressed because of major reinsurers ability to diversify away the risks, take Europe for example.

It’s almost a reverse pricing power, that reinsurers can exert their influence and diversification benefits so strongly still. But at the same time cannot seemingly get the pricing they desire (at least those still seeking the now elusive payback) in regions where their performance hasn’t been so impressive.

Deutsche Bank’s equity analyst team argue that, “pricing power is still a challenge for the reinsurers,” saying price increases after major losses are no longer as large as they used to be.

Overcapacity has been a factor here, of course, with alternative reinsurance capital and insurance-linked securities (ILS) naturally taking part of the blame (as always), with the increased competition the ILS market has brought to reinsurance helping to moderate the rate and pricing cycle.

“But even in markets where alternative capital is less relevant, pricing still appears to be challenged – suggesting it will likely take longer to recoup losses,” the analysts warn.

Japan has been a case in point, as rates failed to rise as expected or hoped for after 2018’s typhoon loss experience.

Now, following 2019 typhoons Faxai and Hagibis, the market is hoping for a better response come the April 2020 reinsurance renewals, but the analysts fear reinsurers may be disappointed again.

Deutsche Bank’s analyst team explain, “Clearly post Faxai and Hagibis, we would expect further price increases to come through in the upcoming April renewals (particularly in flood loss related lines), but we would argue that this relative pressure is a function of increasing competition in the market, and reported price increases may not be as large as the companies would like to push through – i.e. we would not be surprised if the upcoming April renewals were to disappoint relative to current expectations – similarly to what we saw in April 2019.”

They also note that the Japanese market is not as close to being ground-zero for ILS as the United States and particularly Florida, saying, “If we are already seeing pressure here then presumably we can expect to see even greater pressure on pricing post losses in the US/Caribbean (e.g. Dorian) – with the payback period clearly much longer.”

This longer payback period is something the reinsurance market has to get used to, we would venture.

It’s not just being caused by ILS capital, or the excess of traditional capital. It’s also a feature of a modernising market that is adding efficiency in terms of processes, as well as accuracy in terms of its pricing accounting for potential loss costs and this has to affect the pricing cycle as well.

These factors, of efficiency and technical accuracy, are only going to keep improving in the underwriting, analysing and reserving areas of the market, which should all allow underwriters (traditional and alternative) to make better informed pricing decisions, adding efficiency to their capital, while allowing their capacity to be deployed as a product with greater long-term sustainability and stability.

Which should all equal less need to hike pricing significantly when losses occur.

As underwriting capacity and risk capital becomes more efficient, it should eventually reduce pricing power in terms of payback, as well as encourage more risk appropriate pricing in diversifying zones as well.

Technology, in particular, will allow underwriters to make better long-term decisions, which will further moderate the reinsurance market price cycle as well, to the benefit of all parties and importantly the end-consumer of insurance as well.

The analysts give another example of reinsurers losing their pricing power, as the fact they have not been able to pass on the costs of the lower for longer interest rate environment to their customers either.

“There does not appear to be any real evidence that the reinsurers have been able to pass this on to their customers. In contrast, the primary carriers have shown a steady improvement (which we expect to continue),” the analysts explain.

The pricing power levers that reinsurers once had are seemingly not the same any more, or as powerful as they once were.

This January will give us a very clear view of how powerful these levers are, as well as how willing the big reinsurance firms are to make proper use of them.

Reinsurers could push for price increases more broadly across their portfolios and in regions such as Europe, Asia and other diversifiers where rates remain perpetually softened, sometimes at levels that help to keep the competition from less well-diversified capital market players at bay.

The modernisation and technological advancement of reinsurance underwriting practices will only help to make capital more efficient, rates more sustainable and the sector attractive to different types of capacity.

All of which will pull in more capital, provide opportunity for new products and ultimately deliver benefits to protection buyers.

But it does mean that the old school reinsurance pricing power levers are becoming less effective and may disappear completely, only to be replaced by the newer levers of capital efficiency, underwriting expertise and access to technology.

Pricing power will continue to exist, but it will be significantly moderated and fairer, while reinsurance capital gets priced increasingly accurately and sustainably going forwards.

Also read:

– Despite capital on sideline, reinsurers expect payback. Should they?

– Payback has expired, symbiotic relationship with ILS emerging.