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Large European reinsurance firms still meeting cost-of-capital: JP Morgan


Continued market pressures across the insurance and reinsurance landscape in 2015 have, as expected, persisted into 2016, but despite pricing in the global reinsurance sector declining still, analysts at JP Morgan feel the larger European players are still earning their cost-of-capital.

The four large, European reinsurers analysed by JP Morgan in a recent Europe Equity Research report, Hannover Re, Munich Re, Swiss Re, and SCOR, are all still managing to meet their cost-of-capital requirements, regardless of further reinsurance market softening at the key January 2016 renewals, says JP Morgan.

“Pricing is continuing to fall, particularly in nat cats, but the reinsurers have a diversified business mix within reinsurance where the nat cat budget for claims accounts for a relatively modest 7-9.5% of premiums,” explains JP Morgan.

Interestingly, Artemis reported recently that analysts at Bernstein had warned that pricing in the reinsurance sector in 2016 has now fallen so far that reinsurers were unable to generate underwriting returns sufficient to cover the sector’s cost-of-capital.

However, while this is perhaps the case for many global reinsurers operating in the current challenging market landscape, analysts at JP Morgan clearly feel that the four large European players are diversified, and large enough to absorb the current pressures, and still return sufficient profits to meet their cost-of-capital needs.

The reality is that in recent times as the market has been flooded with capacity from both traditional and alternative capital providers, a trend that has been exacerbated by the ongoing benign catastrophe loss landscape, reinsurers’ results have been somewhat flattered by low losses and a possible over reliance on reserve releasing, masking the true profitability of the current market.

Instead, then, it’s once earnings and returns on equity have been normalised, something that reinsurers usually do in order to price and budget for the future months, it becomes apparent that the sector is failing to generate sufficient returns on the underwriting side of the business.

Something that becomes of a greater concern at times of low interest rates, which means that making a return on the investment side of the business is also a challenge for sector participants, at present.

With the four reinsurers set to report on both January renewals and full-year 2015 performance in February/March 2016, JP Morgan expects each of the firms to reveal that they’re still managing to earn their cost-of-equity, also.

In fact, JP Morgan estimates that full-year 2016 and 2017 return on equity for all four players will remain unchanged, at “12.5% and 12.3% for Hannover Re, 9.1% and 8.8% for Swiss Re, 9.4% and 9.6% for SCOR, and 9.6% and 10% for Munich Re. We estimate the cost of equity for these reinsurers is around 8%,” explains JP Morgan.

Regarding pricing at the recent renewals period, JP Morgan expects the four European reinsurance companies to report modestly negative declines, with Munich Re being the least affected, at -1%, and Swiss Re experiencing the steepest declines, of -1.30%.

The analysts continue to explain that declines of 1% to 1.3% are far more modest than the 5% dips predicted in September at the reinsurance industry meeting in Monte Carlo.

The firm attributes this in part to a better business mix, with nat cats (which have experienced the most significant price declines) only being a small part of the firms’ overall business, and the reinsurer with the most exposure to nat cats, being Swiss Re, predicted to report the steepest decline at 1/1 2016.

Furthermore, JP Morgan underlined that terms and conditions held even though pricing continued to soften during the renewal season, and that pricing was actually up in cyber, which is expected to be a growing part of firms’ business mix moving forward as the exposure is better understood.

Of course return on capital is perhaps best assessed when taking into account a normalised level of catastrophe losses, which others such as broker Willis have said reduces the return on equity right down to mid-single figures.

Additionally, it is very hard to really understand the extent and influence of expanded terms and conditions in the major reinsurance firms disclosures of price declines. How are they accounting for longer hours clauses, in terms of price effect, and what about the inclusion of cyber risks in other treaties? These issues are unlikely to ever become that clear until difficult losses occur.

Exactly how much more softening the reinsurance sector can take is the question many reinsurance executives and analysts are surely asking themselves.

Should the benign loss environment continue and competition remain fierce, it will be interesting to see just how far the four, large European reinsurers can continue on the same track before their reinsurance business, particularly natural catastrophe lines, no longer offer the returns needed to meet cost-of-capital and return on equity demands.

The ability to access new, diversified business lines is as important now as ever, it would seem, and for the big four European reinsurers it appears that diversification and scale is what’s keeping their heads above the rest, for the time being at least.

Also read:

“Probably impossible” for industry to achieve 10% ROE in 2016: Catlin.

Reinsurance sector no longer earning its cost of equity: Bernstein.

Reinsurance price pressure to persist, ROE’s to struggle: A.M. Best.

Reinsurer returns on equity more realistic at 5.9%: Willis Re.

Expense efficiency becoming vital as re/insurance ROE targets drop.

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