Rates adequate, returns near cost-of-capital in Lloyd’s renewals: Peel Hunt

Insurance and reinsurance rates in the Lloyd’s of London market declined in line with comments from brokers at the January 1st 2016 renewals and while they remain technically adequate, the returns on underwriting are nearing cost-of-capital, according to analysts at Peel Hunt.

Following a visit to the Lloyd’s market after the January 2016 renewals, analysts from Peel Hunt provided some insight into the renewal, market sentiment among underwriters at Lloyd’s and some thoughts on how market dynamics will develop through 2016.

Further rate pressure was evident across the majority of reinsurance and specialty insurance classes underwritten in the Lloyd’s market, the analysts explained, with pockets of positive growth evident where innovation has helped to generate new business and develop new products.

Diversification remains a key strategy as well, helping some re/insurers to continue to underwrite through the softening market cycle. Although we’d venture this is having an exacerbating effect on some other lines of business, which are feeling additional pressure due to capital deployed at lower returns for the diversification benefits.

However, while rates remain adequate, on a technical and risk adjusted basis, the normalised returns in the market are nearing cost-of-capital across the Lloyd’s sector, the analysts explained.

The Lloyd’s of London insurance and reinsurance market has seen increasing competition, both from traditional and alternative sources of capital, in recent months as the rates available for some of the specialised risks that pass through the market have been seen as more attractive than some of those perhaps more easily accessible.

As rates near cost-of-capital the efficiency of the underwriting capacity within Lloyd’s will become increasingly important, perhaps providing an edge to some of the newer players bringing ILS and alternative capital into the world’s oldest insurance marketplace.

In January the Lloyd’s market experienced rate declines of -2.5% to -15% across reinsurance lines, flat to -10% across specialty insurance lines and aviation down up to -15%. Casualty saw slower declines than specialties such as energy and aviation, as the spill over of excess capital and alternative capital into some specialty risks continues to apply pressure.

“Virtually all short tail lines are seeing single digit to mid teen rate declines. Longer tail casualty is now following suit (low single digit) albeit with a few exceptions such as cyber risk, where rates continue to rise following loss activity. Larger ticket commercial risks are seeing more rate pressure than mid to small sized risks accelerating changes in underwriter’s portfolio mix towards small commercial accounts,” the analysts at Peel Hunt explained.

Additionally, terms and conditions continue to be stretched and weakened, the analysts said, adding that this could be a sign of smaller, more marginalised underwriters having to bow to additional pressure just to get line sizes they need to deploy capacity.

Interestingly, the analysts say that one new T&C expansion appears to be the inclusion of contingent business interruption to property insurance and reinsurance contracts. This is a risky step, as with already expanded hours clauses the addition of contingent business interruption cover to policies could result in some outsize losses, when complex catastrophe events occur.

It’s not all bad in the Lloyd’s insurance and reinsurance market though, with pockets of premium growth available in some specialties and rates on longstanding programs, where relationships have been in place for a long time, holding up much better than the overall market.

Aggregation risk remains a concern, particularly around cyber underwriting, and this is resulting in some additional demand for reinsurance, the analysts note. It will be interesting to see whether the trend of expanded T&C’s, on hours clauses and addition of elements such as BI, could eventually result in an uptick in reinsurance buying as these expansions of coverage do increase the risk of aggregation as well.

Feedback from the Lloyd’s market suggests that further rate declines are expected at the upcoming April, June and July 2016 renewals, as there is no sign of pressure easing and alternative capital remains ready to take advantage of any market dislocation.

Overall the Lloyd’s market does appear discipline, the analysts note, and with no near term prospects for the softening reversing underwriters are adopting strategies to navigate the cycle. Low levels of losses continue to help excess capital build, which should guarantee further special dividends for shareholders in the future.

But “these attractive returns will come under pressure as the cycle continues to soften” Peel Hunt concludes. Which with returns nearing cost-of-capital suggest that the need for discipline will become increasingly important and the opportunity for efficient underwriting capital to increase its participation at Lloyd’s may grow as we move through 2016.

Read all our reinsurance renewals news and analysis here.