Analysis from Alliance Bernstein researchers shows that the property and casualty insurance sector needs to continue to take rate increases of between 5% and 10%, if it is to earn its cost of capital in the aggregate, which likely also applies to reinsurance.
Alliance Bernstein analysts suggest that despite P&C insurers having driven through rate increases consistently for a number of years, this momentum is now slowing and there is increasingly an expectation that this market could turn soft in 2015.
Exacerbating the problem is the already soft reinsurance market, affected by the influx of new capital on top of flush traditional firms with low levels of catastrophe losses. The knock-on effect for insurers could see P&C rates turning soft in the coming year which could come at a very bad time, as the analysts believe that continued rate increase is needed in order to maintain profitability.
The Alliance Bernstein analysts suggest that; “The broad P&C sector still requires around 5-10% real exposure-adjusted rate increases in major lines to reach adequate profitability.”
The 5% to 10% of rate increase is required if P&C firms are to earn their cost of capital, Alliance Bernstein explains, with lines such as workers compensation and commercial auto particularly challenged currently.
Margins remain below the necessary levels to maintain adequate returns in the aggregate, given the low-interest rate environment, warn the analysts. The inability to perform on the investment side of the business makes rate even more vital, if insurers are to maintain a return that will keep investors happy despite the absence of yield.
The analysts go into more detail; “We believe recent quarters’ pricing slowdown will continue. Over the next year, we expect this will lead to more widespread pricing declines, for our actuarial data shows that many companies may be able to afford the reductions, and with signs of competition rising on many fronts, as we look out to 2015, we suspect the industry’s historically unusual pricing discipline is likely to wane.”
Some lines of business only need to see rate increases of 4% to 5%, as they are already adequately priced, but others need 10% or more in order to come into line with expectations. Overall something in the region of 10% across the board is required in order for companies to deliver average return on equity to investors of approximately 9%, say the analysts.
With no sign of the reinsurance pricing environment changing it is hard to see any reversal in P&C insurance rates either, except perhaps on a regional and line of business basis where affected by losses. As a result further softness has to be expected.
The interesting message here is the fact that analysts warn that more rate is required in order to maintain an average return on equity. The same is true of traditional reinsurance firms, many of whom have been boosting quarterly returns thanks to positive prior year reserve developments.
If or when those prior year reserves run out and we have not seen any increase in rate, while at the same time reinsurers have been effectively giving away more for less through expansion of terms, we could see some companies struggling to make a return on equity that will satisfy their investor base.
Lower cost capital may well prove to be king, if these factors converge to squeeze insurers and reinsurers even further. That could make the capital markets and insurance-linked securities (ILS) an even more attractive partner, as companies look to ways to reduce their costs of capital in order to maintain ROE’s.
Generally, reinsurance market trends seem to be being reflected in insurance market rates and pricing at the moment, although with some lag apparent between the two. While market conditions persist as they are the pressure to maintain just average performance may increase.