Rate softening, stimulated by third-party reinsurance capital, is widening: Willis

The softening of reinsurance rates, primarily seen in U.S. property-catastrophe line reinsurance renewals to date, shows evidence of spilling over into other markets, according to the latest reinsurance renewals report from the reinsurance broking arm of global broker Willis.

The latest Willis Re 1st View report takes a look at the reinsurance market after the critical June/July renewals are complete and discusses some of the pricing trends and issues of note that are affecting the marketplace. It’s no surprise that this edition of the report features a lot of commentary on the convergence of reinsurance and capital markets as capital inflows have continued to grow through the first half of 2013.

Willis Re says that traditional reinsurers are now taking ‘robust defensive measures’ in an effort to maintain their positions in the market and to fend off the erosion of their business by new capital markets entrants to the reinsurance space. The key battleground where this is playing out is the U.S. property catastrophe reinsurance space, where the influx of third-party capacity from the capital markets has been so prevalent to date.

John Cavanagh, Global CEO of Willis Re, commented; “Traditional reinsurers’ defensive actions include offering price reductions, larger line sizes and, in some cases, broadening of cover by offering options such as multi-year agreements, extended hours clauses and additional reinstatements. Capacity for aggregate cover is also more widely available. As most programs are well over-placed, buyers are facing the challenge of signing down reinsurers’ shares.”

At the same time the collateralized reinsurance players and the range of collateralized products available continue to evolve, offering increasingly flexible coverage to cedents, more closely matching traditional covers and continuing to minimise clients basis-risk.

Peter Hearn, Chairman of Willis Re, said on the third-party capital trend; “The trend for traditional reinsurers to set up sidecar-type structures, providing third-party capital access to the risk they are accepting, continues to expand. Similarly, the catastrophe bond market continues to grow rapidly and is on track to surpass the previous record high issuance in 2007 of US$ 7.2 billion. With the strong inflow of new funds, the challenge for Insurance-Linked Securities (ILS) fund managers is how to source enough demand to satisfy investor demand for ILS products.”

This challenge of finding somewhere to put capital is increasingly an issue for third-party capital managers, forcing many to stop taking on new capital until the market has more opportunities available. Others are being strategic in establishing partnerships with cedents that regularly need to cede risk and appreciate a ready source of capital.

The report from Willis Re says that this challenge of putting money to work is made even more difficult as the ILS and third-party reinsurance capital has to date been largely focused on U.S. property catastrophe reinsurance business. Growth of this market is modest, and take-up of capital market solutions in other markets lags behind, meaning that there is a lack of business right now. Willis Re suggests that even the price competitiveness of ILS and collateralized over traditional reinsurance here will not be enough alone to help all the capital into the market, which suggests that the ILS market needs to broaden its scope in order to grow.

However, Willis Re sees the softening of reinsurance rates spilling over into other classes of business, as well as traditional reinsurers’ desire to maintain their positions in the market. The report cites casualty markets as an area seeing substantial capacity increases globally and as a result some price softening. Casualty is also one line of business where a number of ILS managers are beginning to turn their focus, so perhaps this is where the next stage of the evolution of the reinsurance markets capital sources will occur.

The momentum behind the capital markets push into reinsurance has escalated, according to Willis Re, which is accentuating the increased supply of capitals hunt for a much slower growing property catastrophe reinsurance market and its opportunities. This has led the traditional reinsurers to adopt this defensive stance to maintain position, but at the same time is stimulating innovation in the ILS and capital markets space which helps to make the offering even more attractive to potential cedents.

Willis Re estimates that at the end of 2013 the amount of in-force cover from collateralized and ILS markets will sit around the $42 billion mark, which is around 15% of the total global reinsurance capital total. The report notes that this is potentially a drop in the ocean when you consider that if global pension funds decided to allocate as little as 0.5% of their capital into reinsurance that could see as much as $150 billion of new ILS capacity come into the marketplace.

The U.S. property catastrophe renewals market saw high levels of competition at the recent renewals, with managed ILS funds, sidecars and catastrophe bonds all taking share. Willis Re says that the capital markets have been increasingly aggressive in competing with traditional reinsurers which has led the reinsurers to be defensive and adapt their offerings to defend market share.

This is being seen as a very positive market dynamic by many, as it is forcing traditional reinsurers to be flexible and innovative to keep business while ILS players are being forced to innovate as well and come closer to matching cedents needs in order to take bigger lines on renewals. The end result may actually be a better functioning, more healthy and competitive reinsurance marketplace, which will be positive for all involved over the longer-term.

Other regions of the world are not seeing the impact of third-party capital on reinsurance pricing, with international catastrophe reinsurance business falling much less than U.S. lines. This is a situation that may change over time, but for the moment the focus is going to be largely U.S. based until ILS can further expand its reach.

Retrocession pricing was seen down 5% to 10% at the mid-year reinsurance renewals, with pressure from the ILS market taking its toll. Willis Re also noticed what they call a significant increase in industry loss warranty activity with cedents making the most of attractive pricing before the U.S. wind season began.

Generally, catastrophe bonds issued in 2013 are much more at risk than those issued a few years ago, according to Willis Re. It was that this is indicative of an evolving catastrophe bond market, with investors more comfortable taking on higher levels of risk for lower returns.

Interestingly, Willis Re believes that the syndicated approach to marketing ILS and catastrophe bond deals is resulting in better pricing that those placed with a limited range of markets. It puts a more transparent bookbuilding process and new-found price discovery for investors as key issues driving this change. This is a positive step for the cat bond market and one which could become even more prevalent if we ever get to a stage where 144A cat bonds can be more publicly marketed.

ILS investors are themselves beginning to look outside of property catastrophe business, with lines such as life, commercial, auto and casualty index products the main focus. This is again a positive trend and one which will help to stimulate creation of new products which will in turn open the market to new opportunities and allow more capital to flow in.

The report paints a picture of a market in the midst of an evolutionary stage, with capital markets and ILS winning market share which is in turn making traditional reinsurers become more flexible and innovative. This is no bad thing. In fact this kind of evolutionary market change is perhaps one which was due in the reinsurance market and will in the long run benefit cedents and market participants alike.

There are going to be a difficult few years for some players in the reinsurance and capital markets, as the dynamic evolves, and it will be those which remain flexible, open to change and embrace innovation irrespective of capital sources, that will likely emerge as market leaders in the end.

You can access the full report from Willis Re via the press release here.