ILS triggered reinsurance rate decline to colour outlook for Lloyd’s firms

The outlook for insurers and reinsurers engaged in the Lloyd’s insurance market in London looks potentially gloomy, according to an analysts report from Christopher Hitchings of Keefe, Bruyette and Woods. The report states that the recent setback in reinsurance pricing could lead to gloomy market commentary on firms at Lloyd’s.

Lloyd’s market insurers and reinsurers have had a decent first-half to 2013, with low catastrophe losses and profits slightly ahead of the same period a year earlier, despite lower investment gains. Despite this good start to the year, analyst firm KBW expects declining rates to impact firms operating in the Lloyd’s markets, citing capital markets alternatives such as insurance-linked securities (ILS) and new broker facilities bringing, potentially cheaper, capacity into the market.

The impact of third-party alternative reinsurance capital, largely sourced from institutional investors such as pension funds and deployed in instruments such as catastrophe bonds, sidecars and collateralized reinsurance, is now having an effect on the Lloyd’s of London re/insurance market.

KBW note that there has been a setback in reinsurance pricing and also across specialty lines in the London insurance market. It believes the average decline across reinsurance and specialty lines in the Lloyd’s and London insurance market to be approximately 5% in the second quarter. KBW also says that while U.S. retail insurance rates appear to still be rising, it does see a slowing of momentum.

It attributes the declines and slowing of price increases to the influx of ILS and capital market sourced capital, which accelerated its pace in 2013, as well as to new broker facilities in the London market. KBW is likely referring to the Aon – Berkshire Hathaway sidecar facility at Lloyd’s in this case.

At this time KBW is not turning negative on insurers and reinsurers at Lloyd’s due to these two factors which have reduced the cost of capacity and increased competition. Instead it says that it expects these trends to ‘colour commentary’ for Lloyd’s and London market insurers and reinsurers and to weigh on share prices.

In another update from KBW it discusses the impact of rate decreases across other re/insurance lines. KBW says that while third-party capital is clearly having an impact on catastrophe reinsurance and some other lines of business it does not expect it to materially impact other insurance or reinsurance lines beyond a temporary blip.

KBW notes that capacity alone does not drive pricing across many lines of insurance and reinsurance business, that catastrophe losses do not typically drive rate increases across the whole industry and that it expects an upwards trend in low-cost inflation to keep momentum moving on many lines of business.

Of course, this is while third-party capital stays focused on property catastrophe reinsurance business. Should that focus broaden considerably to investing in underwriting of other areas of the market then we’d expect downward pressure to feature across many other lines of insurance and reinsurance business.

It’s further anecdotal evidence that the impact of third-party capital on the reinsurance market is wide-spread and beginning to affect markets outside of pure catastrophe reinsurance. As the trend continues to grow we expect these gloomy commentaries to continue, particularly for those re/insurers who fail to embrace capital market opportunities.