Profitability a challenge despite reinsurance rate stabilisation: Morgan Stanley

Despite signs of rate stabilisation in the global reinsurance market at the key January renewals, analysts at Morgan Stanley have warned that continued pricing below loss cost trend will contribute to further margin deterioration, while reserves are likely to diminish further.

Property catastrophe reinsurance rates have witnessed a -30% cumulative decline during the last two years, according to Morgan Stanley analysts, continuing to decline at January renewals by -5% in the U.S., and by -10% in Europe, with both insurers and reinsurers facing persistent market headwinds.

“We could be in the early stages of pricing stabilization as traditional reinsurers earn single to low-double-digit returns and alternative capital growth has slowed in property re,” says Morgan Stanley.

Perhaps offsetting any potential positives from an apparent stabilisation of property reinsurance rates in recent times, analysts note that continued declines across the sector coupled with a lack of losses suggests diminished profitability in the coming months.

Morgan Stanley cites that excluding catastrophe events and reserve releases, “pricing below loss cost trend (albeit benign in recent years) will result in core margin deterioration.”

This suggests that in the current market environment, which is underlined by stiff competition, ample capacity, and an ongoing benign catastrophe loss trend, continued declines in pricing will see reinsurers struggle to achieve desirable returns on certain business lines, absent reserve releasing, which is something the analysts also expect to dwindle in the coming months.

With this in mind, should losses return to more normalised levels, prices continue to decline, and reserve releases dwindle owing to undisciplined releasing and a lack of events in previous years, the impact of pricing below loss cost trend on reinsurers’ balance sheets could be significantly more adverse.

Ultimately, the persistence of market headwinds and resulting declines in pricing challenges reinsurance firms ROEs, and Morgan Stanley estimates that “every 5% pricing decline could impact ROE by more than 200bps.”

Applying this estimation to the fact that during the last 24 months rates have experienced a -30% cumulative decline, with a further -5% recorded at 1/1 and more declines expected throughout the year, it’s easy to see how challenging the softening market landscape can be, and how important relevance, scale, and discipline are to navigating the tough times.

One such way reinsurers have attempted to navigate the softening market, with some doing so more prudently that others is reserve releasing, as a way of boosting profitability when returns are minimized on both the underwriting and investment side of the business.

While this is a natural and viable trend in a market with more normalised losses from catastrophe events and absent persistent rate declines, in a market that we see today aggressive or imprudent releasing could result in some reinsurers exhausting their reserves, while a lack of losses limits the opportunity to re-fill.

“Reserve releases have been resilient but could become a smaller contributor to earnings as reserve cushion diminishes,” says Morgan Stanley.

Looking into 2016 Morgan Stanley expects further pressure on casualty reinsurance rates as primary pricing decelerates and “reinsurance capital allocation moves from property to casualty re.”

Many of the challenges witnessed throughout 2015 then, were evident during January renewals and are expected to continue as the market moves further into 2016.

Current trends, including benign losses, diminished investment gain opportunities, and ongoing rate declines are hindering reinsurers’ profits as it is, but this will likely become much more pronounced should losses return to more normal levels.

Those in the sector that have masked true profitability in recent times by aggressively releasing reserves, and those that perhaps practiced more undisciplined underwriting than perceived, run the risk of being caught out and exposed when the market does eventually start to turn and losses return to more normalised levels.