Of all the segments within the insurance and reinsurance market, it is the reinsurers that analysts at RBC Capital Markets believe face the strongest headwinds still, as indicated by some companies higher than expected combined ratios at the mid-year point.
Non-life insurance remains more attractive than life, according to the analysts, with the exception of the reinsurance industry. RBC’s analysts believe that reinsurers face greater difficulties going forwards than the insurers or Lloyd’s of London players.
Some of the largest European reinsurance firms missed on analysts consensus estimates for their combined ratios at the recent results season and RBC believes this is a reflection of the challenges that reinsurance companies continue to face.
The whole insurance and reinsurance sector faces headwinds, it must be said, with the low to negative interest rate environment a constant threat to re/insurers abilities to make the asset side of their businesses work for them.
As a result there has been a shift in investment strategies, as CFO’s and investment teams seek out returns from slightly less safe assets than the sector might have been used to previously, but flexibility here is limited and the investment returns of past years are not expected to return to the re/insurance sector for some time.
Reinsurance firms face the added threats of a very soft market, where pricing has been depressed consistently for a number of years now. With traditional reinsurance capital at excess levels, while alternative capital from ILS funds and capital market players keeps eating away at core areas of P&C reinsurance, this pressure is unlikely to depart anytime soon either.
Reinsurers were not just hit by higher catastrophe loss activity in the last quarter, as the Canadian wildfires, Japanese earthquake, severe weather in the U.S. and Europe as well as man-made losses like the Jubilee oil field claim took their toll, but the asset side also underperformed in many cases.
This, on top of a difficult organic situation where returns on business underwritten is not always meeting the cost-of-capital anymore, is making life no easier for the traditional reinsurance world.
Of course the same headwinds are also affecting capital markets players, such as ILS fund managers, or investors in reinsurance sidecars. They also face the same market dynamics and broader economic policy does impact institutional investment markets, which is where the capital ultimately is sourced from.
But ILS and capital market players continue to have an advantage in terms of cost-of-capital, which helps them to continue to grow in certain markets. However, as traditional reinsurers increasingly wield their diversification in order to maintain market share this is perhaps less of an advantage, in securing new business, at this particular point in the cycle.
And top-line growth did continue at a number of the larger reinsurance firms, with some displaying a continuing appetite for areas of the market like European property catastrophe risks where margins are perhaps at their slimmest. Others continue to expand into longer-tailed lines, from casualty to mortgage risk, the ramifications of which will not be fully known for some time.
RBC analysts continues to advise their clients, which are largely institutional type shareholders in the insurance and reinsurance sector, to hold an underweight stance in European insurance markets, with the biggest challenges seen in reinsurance or areas such as UK life insurance.
But, as long as the level of losses remains manageable by the reinsurance industry and no major erosion of capital is seen, reinsurance will continue to provide a valuable investment for shareholders as the returns are still attractive compared to many other sectors.
While headwinds may persist and show little sign of disappearing, the reinsurance sector remains profitable, at least from the outside looking in.
The question is whether the current headwinds are eroding the fundamentals of reinsurance market participants?
Whether lower underwriting returns and use of reserves to boost performance can be sustained, whether higher competition from efficient players can be fended off, and whether the use of diversification in order to underwrite risks at levels where returns are de minimis and shrinking will still look like a prudent strategy in years to come? All questions that will only be answered in good time.