Despite many reinsurers adjusting their strategies in order to mitigate the impacts of the softening market landscape, ratings agency A.M. Best has warned that the depth of testing market trends will prove too much for some reinsurance companies.
Following further rate declines at the recent April renewal season and with more of the same expected at the important mid-year renewals, reinsurers continue to struggle to find true underwriting profitability in today’s market environment.
Ample capacity from both traditional and alternative reinsurance capital providers continues to flood the sector, driving an intensely competitive marketplace that is underlined by the persistent benign loss environment, low investment returns, and ultimately diminished profitability.
In an effort to mitigate the impacts of the current softening reinsurance industry, some companies have seemingly relied on prior accident year loss reserves in order to bolster reported returns, a trend that could come back to bite some firms once losses return to more normal levels.
“Low investment yields, continuing pressure from the presence of ample convergence capital, and the likelihood that net favourable prior year loss reserve developments will soon wane could lead the reinsurance market to produce less impressive returns,” warned A.M. Best.
In an effort to adapt to the challenging operating landscape some reinsurers have adopted different strategies, notes A.M. Best.
This includes hybrid models that focus more on the investment side of the balance sheet, strategies that utilise the wealth of third-party investor capital to improve efficiency and diversification, and some have been seen to pull-back on reinsurance lines and focus on the less competitive, more attractive primary business areas in an effort to remain relevant.
A.M. Best highlighted that the hedge fund, or hybrid reinsurer model, which can be seen with Greenlight Re and Third Point Re, struggled in 2015 owing to poor investment management results, “and this could impact the proliferation of new, similar market entrants over the near-term.”
Beyond adopting a new business model, others in the reinsurance space have participated in some form of merger and acquisition (M&A) activity, although some in the industry has questioned the benefits of this.
However, “Despite what may be the deployment of sound strategies, not all reinsurers will survive in the end,” states A.M. Best.
A warning that suggests, despite the adoption of new, or restructuring of existing business models in an effort to remain relevant to the market, for some in the global reinsurance market the pressures might simply be too much, and the resulting returns too little to survive.
For reinsurers that have developed a solid foundation of effective and proven underwriting and reserving practices, A.M. Best feels likely already have portfolios in place that enable them to “remain relevant and profitable in today’s market.”
Again, as with so much industry commentary during the current market landscape, disciplined underwriting is brought to the forefront of discussions.
But discipline doesn’t mean reinsurers should neglect innovation and growth, particularly when it concerns the wealth of alternative reinsurance capacity willing and able to be utilised.
A.M. Best highlights the need for reinsurers to embrace capital markets investor-backed capacity in the coming months, saying; “Adding or enhancing the expertise in managing third-party capital to their own advantage will only serve to make such reinsurance organisations more formidable competitors over the long-term.”
“Reinsurers that prudently diversify their portfolios, broaden their product and geographic scope, and employ capital management strategies that show foresight in the face of this challenging cycle are the best candidates to effectively maintain advantageous market positions through the current underwriting cycle and remain attractive to equity investors,” said A.M. Best, adding that those with the ability to pursue opportunities in both insurance and reinsurance areas stand to realize additional benefits.
“In 2016, the reinsurance industry will continue evolving into a new reality for what it will take companies to survive and flourish in the “new frontier.” The prevailing perception is that this industry will be much different from what market participants and observers have seen in recent decades,” concludes A.M. Best.
The success or failure of the varied business models and the companies that adopt them remains to be seen, and will most likely become clearer once losses return to more normalized levels.
It’s also important to note that if the current market environment, of soft reinsurance rates, expanded terms, discounting heavily for diversification and reducing returns on equity hits some reinsurers, then some ILS players may also find surviving this environment challenging as well.
The added efficiency of lower-cost capital and business models may help, but if ILS players are to “survive and flourish” discipline will be essential, as will be prudent growth strategies and innovation.
A challenging market affects all sides, but traditional players that fail to control their efficiency and take on too much risk may be the most threatened.