ILS to limit mid-year rate rises, positive for reinsurance buyers: KBW

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The continuing growth of the insurance-linked securities (ILS) market, the strong appetite being shown by catastrophe bond investors and the ongoing inflows of alternative capital from institutional investors into the reinsurance market, will limit rate increases at the mid-year 2018 renewals, KBW says.

The analyst firm Keefe, Bruyette & Woods says that it expects ILS will be a factor that limits the ability of the reinsurance market to increase rates as much as it would like at June 1st and July 1st renewals this year.

The analysts highlight that the ILS market is experiencing, “Continuing inflows that we expect to limit mid-year property catastrophe reinsurance rate increases,” and also cites evidence from recent broker market reports that the catastrophe losses of 2017 haven’t boosted reinsurance pricing outside of the regions impacted by those events.

On a relative basis, spreads on U.S. wind exposed ILS and catastrophe bonds are coming in relatively flat on where they sat at the end of 2017 and so far are down year-on-year.

On ILS and catastrophe bonds not exposed to U.S. wind, spreads are down on the last quarter of 2017 and down year-on-year as well.

All of this suggests that ILS spreads at the mid-year will be flat to down, with some cases of small rises for loss impacted sponsors perhaps.

Evidence from recent catastrophe bond pricing suggests this to be the case, with all cat bonds pricing towards the lower-end of their coupon guidance, something that is not anticipated to change as the renewal nears.

However, KBW does expect catastrophe reinsurance rates to be up overall at the mid-year, mainly because of the significant proportion of renewing accounts that were loss affected.

But KBW’s analysts caution that, “The magnitude of rate increases will disappoint any optimistic expectations,” which the firm says leaves them cautious on recommending catastrophe focused reinsurers, such as the Bermudians, but more positive on homeowners insurers, such as the Floridians, which will benefit from competitive reinsurance renewal rates.

Early indications are that primary insurers which have demonstrated their ability to manage claims effectively will get the better reinsurance rates and terms, in the loss affected regions. While those that have not shown an ability to manage claims creep and inflation could find they are subject to the largest rate increases come renewal time.

While some may bemoan the fact that alternative capital and the ILS market influences the ability of underwriters to secure their much-needed pay-back, following the catastrophe losses of 2017. This is a positive for all market participants, making protection more efficient and affordable, providing options to leverage reinsurance and retrocession as capital tools for their own growth.

It’s a positive for buyers of reinsurance, that can become better protected at lower cost, and for buyers of retrocession, that can access more efficiently priced hedging for their portfolios.

It can even offer some an ability to arbitrage the market, benefiting from price increases on the front-end, particularly for those moving up the value chain such as reinsurers with commercial insurance underwriting arms, while capitalising on lower priced reinsurance and retro.

ILS will, of course, be blamed for any lack of rate increase at the mid-year renewals, but with traditional reinsurers equally awash in capital and just as competitive when it comes to filling their portfolio buckets, especially where any rate increases are found, it is far too simplistic to blame the capital markets alone for the depression of post-loss rate rises.

Of course the reasons behind this are many, but a key one is that underwriting returns are not always meeting the required cost-of-capital for many traditional firms. Therefore, despite the benefits of cheaper retro and reinsurance, they will still find someone to blame for the inability of their business models to deliver the profits they were historically able to.

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