A shift towards underwriting more reinsurance business on a quota share basis could matter more for the forward-profits of many large reinsurers in 2021, than the lower-than hoped for rate increases in excess-of-loss treaty pricing, analysts at Barclays said in a report yesterday.
The reason for this, according to Barclays equity analyst team, is that more momentum is coming from the bottom-up, through the persistent price increases seen across primary insurance, combined with flat to reduced ceding commissions, than is now being seen in broader reinsurance market pricing.
This puts an increasing focus on primary insurance rates as the source of improvements in return-on-equity for reinsurers, as many of the larger reinsurance firms continued to show an increased appetite for entering into quota share arrangements at the January 1 renewals.
The analysts explain that, “This means the increases in primary rates (+10-20%) and the reduction in cede commissions (flat to -2%) may matter more than the headline rate on excess of loss treaties that the press typically focuses on.”
It’s a very good point, as after renewals are over the focus does tend to be on where reinsurance treaty rates have come in, rather than the additional dynamic of how much risk is flowing and being assumed through proportional and pro-rata type arrangements.
Anecdotally, the analysts say that they understand there has been a shift to writing more quota share business at the January 2021 reinsurance renewals.
The analysts from Barclays note that some of the larger reinsurance firms books, such as the big four European reinsurers, are as much as 50% to 70% made up of quota share arrangements, which means they stand to benefit from increasing insurance pricing lying underneath these transactions.
The same goes for insurance-linked securities (ILS) funds with a focus on quota share arrangements, as they too can benefit from the better rate momentum being seen in primary lines of business.
When you consider primary property insurance risks, personal or commercial, it is the catastrophe exposed areas of the market that see their rates accelerating fastest as well, which of course is the sweet-spot for most ILS funds allocating to quota share sidecars, or underwriting their own private quota share based ILS and collateralized reinsurance deals.
Even when the headline rates and momentum is less impressive, with the way the market is moving now the analysts say that volumes through quota shares are expected to be more so, providing favourable tailwinds for very large reinsurance books with a high percentage of quota shares in them.
The same dynamic can provide tailwinds for those ILS investors and funds allocating to proportional deals like quota shares.
The firming of insurance rates means premiums that flow through these arrangements may come with better pricing attached than an XoL reinsurance treaty would be able to command.
Where quota shares are concerned, it’s important to also consider alignment here, as choosing who to partner with in quota shares is vital for ILS funds, given their portfolios are typically not of the breadth and scale as a the major reinsurers.
It’s also worth considering the fact that quota shares help to bring capital further towards the front of the market chain, linking it more directly to the underwriting performance of a primary carrier, rather than sitting it behind their performance only when losses strike, as excess-of-loss may be seen to do.
Of course, quota shares aren’t for everyone and some underwriters will shun them, preferring treaties to build a portfolio.
In addition, the ILS market has taken more than its fair share of losses through private quota shares and sidecars in recent years, which has turned some off the investment prospects of any proportional type deals.
Issues like loss creep, the influence of social inflationary factors and more recently the COVID-19 pandemic, all impacted quota shares to some degree over recent years, causing a large share of losses to flow to some ILS funds and investors.
The upshot of that was that the terms of reinsurance sidecars and private ILS quota shares were carefully assessed and changes made to protect investors better and ensure it was more clearly understood what was covered and included in them.
With market dynamics perhaps showing that now is a better time to get into the quota share space, we may see more capital market investors looking to the ILS strategies which specialise in them at this time.
Of course, if the rate momentum in primary lines persists it will result in further support for excess-of-loss pricing as well, so that dynamic stands to benefit all underwriters of reinsurance going forwards, no matter what structure they choose to allocate to.
While the shift to quota shares may matter a lot for the very largest reinsurance writers, for the smaller and the ILS market how the excess-of-loss marketplace responds to primary pricing trends still matters a whole lot more.