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Price trajectory converging between reinsurance & insurance: Credit Suisse


Reinsurance pricing has been on the decline for a number of years, as regular readers will be all to aware, but during much of that time primary insurance lines still saw rate increases. That could be changing as price expectations start to converge, according to analysts at Credit Suisse.

“For a number of primary lines the rate of pricing declines has begun to converge with reinsurance,” Credit Suisse equity research analysts Ryan Tunis, John Nadel and Crystal Lu write in their latest report on the U.S. P&C insurance sector.

As reinsurance pricing has declined so far you would have thought that primary lines would have followed the market down, but this hasn’t always been the case. Yes, some property catastrophe exposed areas saw some declines, but many others saw increases in recent years as pricing perhaps got to levels that were more commensurate with the risk.

But now it seems the primary insurance market may be less able to hold prices up and rates are destined to fall more closely in tandem with reinsurance.

As a result, the Credit Suisse analysts highlight that; “The margin outlook for primary commercial is not improving.”

In fact the analysts say that the reality of margins, particularly in peak years of loss, have been priced into the stocks of commercial insurers even while pricing had held up. But now they believe that pricing is set to decline to levels where margins are more commensurate with the way the market has been pricing the equities of large primary commercial insurers.

“After several years of steep reinsurance pricing declines – during most of which the primary insurers were still receiving rate increases – heading into 2017, our expectations for further margin deterioration for the primary insurers are now fairly consistent with our view for primary P&C pricing,” the analysts explain.

But a warning for the equity investors who have favored primary insurance stocks over reinsurance; “A better relative rate of decline no longer seems like a viable thesis for preferring the primary space to the reinsurers.”

So if pricing is set to decline, is this simply a realisation that the cost of risk capital is declining as efficiency increases in the industry?

This has certainly been a factor in reinsurance price declines, as the insurance-linked securities (ILS) business model and structuring technology has shown the market that there are both better ways to deploy capacity and pools of willing underwriting capital which have a lower cost.

As risk capital from ILS funds is now being directed into primary lines, by directly backing the aggregated pools of primary policies, while major global reinsurers are almost all writing primary risk or backing primary companies and technology players, again as a way to get their capital closer to the source of risk, primary rate expectations really should align with reinsurance.

Insurance technology or insurtech developments are set to accelerate the deceleration, as risk capital becomes increasingly efficient and lower cost due to its much closer proximity to risk and lower friction channels of distribution.

As was seen in catastrophe reinsurance with the ILS fund model, deploying lower cost capital in lower friction structures, so backing the risks more directly.

Ultimately it is all about the increased efficiency of risk capital and application of innovative business models, structures, technology, to bring efficient capital to risk more directly. Having impacted reinsurance, this has also impacted primary insurance, it’s perhaps just taken longer for it to sink in (or for the effects to bubble to the surface).

Credit Suisse’s analysts explain that the data shows that the convergence of pricing trajectory is perhaps most apparent in catastrophe exposed property lines, based on certain re/insurers reporting that both insurance and reinsurance rates are expected to decline at the same pace, which is no surprise.

However, the analysts still feel that the “fundamentals remain far better for the primary insurance business than the reinsurance business.”

However, fundamentals do look better for reinsurers, helped by more normal loss years allowing numbers to adjust downwards closer to consensus estimates and an expectation that future rate declines will be more gradual.

So expected results for reinsurers are becoming more aligned with investor expectations of mid to single digit returns on equity (ROE’s), according to the analysts.

The report also mentions the need for primary insurers to adopt “more efficient cost structures” something that has also been forced upon reinsurance companies and that they are just beginning to really try to embrace.

It’s one way to “combat a structural lower investment return environment” and perhaps also a way for insurers to get to grips with the potential that rates just keep steadily declining as efficiency rises in the industry and the distribution and deployment of risk capital.

If risk capital is increasingly efficient and lower cost, it stands to reason that both insurance and reinsurance rates should gradually move downwards in tandem as the risk capital efficiency rises.

This seems to be a trend globally and across industries, that capital has become cheaper, more efficient and increasingly fungible, so perhaps this is the new normal that has been so discussed and re/insurers just need to get on with embracing and learning to live with it.

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