Pricing power is gone, negative outlook for Jan 2019 renewal: Deutsche Bank

Analysts at Deutsche Bank have conclude in a new report that the reinsurance renewals so far this year show that reinsurer pricing power is gone and that price increases seen are insufficient to reimburse reinsurers losses, suggesting a negative outlook for the next major contract signings in January 2019.

Pricing has lost all steam as we headed through the mid-year 2019 renewals, Deutsche Bank analysts believe.

“We do not expect pricing for July renewals to gain significant momentum from here, which suggests that pricing will be insufficient to reimburse for 2017 hurricane losses,” the analysts explained.

There had been an expectation among analysts tracking reinsurance that rate increases would have continued to improve at the mid-year renewals, given the concentration of loss affected accounts, but now the best that is being hoped for is a stable rate environment with pricing at levels seen at earlier renewals this year.

With the major reinsurance firms all due to report their first-half results in the next fortnight or so, the analysts expect that reinsurers will not have been able to push through further material rate increases in July.

Overall, Deutsch Bank’s analysts are anticipating that rate increases in July will be in a range of 1% to 3%, as reported by the major reinsurers, which is less than half the 3% to 4% range that had been expected earlier this year.

Decelerating rate increases are expected to be the norm and while loss affected accounts have been seeing rises, these are expected to plateau and it is likely these accounts will return to some level of price decline over the next year.

With major reinsurance firms being unable to push through the price increases they would have liked so far this year, the prospects for January are now looking bleaker.

The reinsurance market is back at a record size, in terms of capacity, and in addition the alternative capital market and ILS funds now account for at least another $100 billion of capacity (and continues to expand).

As the ILS fund market grows and the influence of these fund managers increases, it has removed pricing power in some cases from the traditional reinsurers and left a situation where the price is being set by the least conservative underwriters, those with the most diversification discount to spend, or those with the most efficient capital.

We’ve discussed this before, that pricing power has shifted towards three groups that now stand to command significant power at renewal seasons.

The least conservative is often the reinsurance price setter, as programs can get repriced during the placement process all because one market has a lower pricing ambition than others. This is often wielded as a way to get larger shares of programs, but it can also easily be confused with the other two (diversification strategies or lower-cost capital providers).

The major global re/insurers can wield significant ability to underwrite at lower pricing thanks to their broad diversification within their underwriting portfolios. This has even made some catastrophe markets almost a no-go zone for ILS funds that cannot compete at pricing levels that fall so close to expected loss, having margin to make and smaller, less diversified portfolios.

Finally, the ILS market and those reinsurers with differentiated strategies designed to enhance the efficiency of their underwriting capital can also be price setters. This is best seen in some of the peak catastrophe zones, where large reinsurers are sometimes restricted by catastrophe concentration and capital charges, so cannot push the diversification angle so hard.

One factor hard at work in reinsurance markets now is competition, precisely because of the above. But still the market does not always function as it should do, clearing risk to the capital with the right cost and appetite every time.

So pricing power is not completely gone from reinsurance, but it does seem to be more evident on declining pricing rather than rising these days.

But one problem is that market access remains uneven, which means reinsurance pricing levels may not always reflect the true appetite and ability of capital providers to underwrite and assume risk.

If the matching of risk and capital can be fully democratised in future, we can expect a market much better able to find a pricing level that is both right (risk commensurate), driven by the appetite and ability of capital’s efficiency, and likely more sustainable for the business models that will persist.

Interestingly though, the ability to wield diversification as a tool to underwrite more risk is expected to be more than evident in the results of the July renewals again.

The analysts expect most, if not all, of the major reinsurers will report underwriting volume increases for the mid-year renewals, as they seek to bulk up on as much higher priced risk as possible to boost portfolio returns.

Volume increases of as much as 10% are mooted for some, which at prices that are expected to be level with January will still offer the reinsurers a higher performing portfolio.

Hence, while nobody will tell you that rate increases following the major losses of 2017 have been sufficient, it is apparent that they have been good enough to whet the appetite.

It’s unlikely January renewal rates will whet the appetite in quite the same way and it will be interesting to see whether those that have upsized their portfolios may begin to pull-back as pricing returns to softening, absent some new source of demand.