Reinsurance outlook stable, despite influence of alternative capital: Fitch

Fitch Ratings said yesterday that it is keeping its outlook for the global reinsurance sector as stable and expects to affirm the majority of its sector ratings in 2014. This despite a market impacted by falling prices across property catastrophe risks and increasing competition from alternative reinsurance capital.

Fitch said that reinsurers current capitalisation is strong, in fact the sector may be considered over-capitalised at the moment due to both traditional reinsurers strong positions and the inflows of third-party capital which have come into the space in recent years. Absent a major catastrophe or a much broader soft market with lower pricing spreading, Fitch sees no reason to expect a major deterioration in the sector.

“The investment environment is likely to provide the greatest challenge to the reinsurance sector in 2014,” said Martyn Street, co-head of Reinsurance at Fitch. “We expect continued low interest rates, which will make it more challenging for reinsurers to achieve similar 2014 profitability to that forecast for 2013.”

Fitch does expect reinsurance pricing to fall at the January 2014 renewals and beyond, assuming no significant loss events occur. It puts this down to surplus capacity in the reinsurance market and the influence of alternative reinsurance capital and insurance-linked securities (ILS).

“There is likely to be a disparity in overall pricing movements, but soft market conditions are likely to broaden to more product classes,” commented Brian Schneider, co-head of Reinsurance at Fitch. “While Fitch expects prices to remain adequate across major classes, underwriting discipline will be tested. We also expect continued competition between traditional and alternative reinsurance.”

So Fitch does expect the competition between traditional and alternative reinsurance will continue but for the moment doesn’t expect this to affect its outlook on the stocks of reinsurers which may be on the receiving end of this competition. Fitch does expect price softening to broaden and believes this will result in some disparity in the direction of pricing across classes. Fitch does say that the price environment is expected to test underwriting discipline, which may push reinsurers into moving their focus into new areas at times.

Pricing and other factors will make earnings sustainability more challenging for reinsurers in 2014, according to Fitch. It expects technical profitability in terms of combined ratio will decline by over 6%, moving its expected combined ratio for the sector in 2014 to 96.8%, from 90.5% in 2013. Low investment yields will exacerbate this as investment income is not expected to make a huge contribution once again.

Pricing discipline is going to be key and reinsurers are expected to try to protect prices at the 2014 renewals. How much influence alternative capital will have on this is not yet clear, but the general trajectory is almost certain to be downwards, large losses aside.

On top of price increases, reinsurance buyers are benefitting from better terms, multi-year agreements, additional reinstatements and an increase in aggregate covers. This trend is likely to continue as traditional reinsurers compete with alternative capital and seek to provide products that it sometimes struggles to offer.

It is excess of loss reinsurance that is suffering the most, according to Fitch, particularly in higher layer property catastrophe reinsurance and retrocession where capacity and competition from alternative capital is highest. Fitch believes that this trend is set to continue, that capital will continue to flow into this space through catastrophe bonds, other ILS, industry loss warrants (ILWs), collateralized reinsurance vehicles, sidecars and other methods.

Pricing of these alternative reinsurance products are particularly competitive with traditional reinsurance and Fitch believes that this convergence between the reinsurance market and the capital market will continue for the foreseeable future. Fitch will be publishing more of its thoughts on the capital markets inroads into reinsurance in early September.

Combined with this surplus capital, more competition is less demand for reinsurance as well and Fitch expects that to be a trend we see more of, as insurers seek to retain more risk in both property and casualty lines of business. This will further exacerbate price declines, according to Fitch.

While the supply of reinsurance remains abundant, particularly with new capital emerging in the form of alternative reinsurance structures, says Fitch, as well as no increase in demand for traditional reinsurance products a continued downward pressure on pricing is to be expected.

Interestingly, Fitch provides some areas of opportunity, one being crop insurance which as readers will be aware is an area that some collateralized players currently see as a potential opportunity. Other opportunities for reinsurers include excess and surplus and specialty lines of business, which again have already begun to attract some third-party capital managers.

Other opportunities may come from the renewal, or otherwise of the U.S. terrorism reinsurance facility and also from reforms in Florida which may increase demand for reinsurance. Will traditional reinsurers be the ones to capitalise on these possible growth areas or will alternative capital cast its eye there as well? Florida is likely well in the sights of the ILS market and terrorism risk is another class of risk that is increasingly being discussed by third-party capital and ILS managers as an opportunity.

In order for Fitch Ratings to change is view and revise its sector outlook from stable to negative, a single loss event of USD60bn, coupled with a sudden spike in interest rates of 300bp or more, combined with an inability for reinsurers to replenish lost capital would be necessary, it said. This would likely result in negative rating actions.

Fitch notes that such a combination is rare, but we’d like to suggest that perhaps Fitch misses one possible outcome to this scenario, that after such events maybe traditional reinsurers will replenish their lost capital with the help of third-parties. How would that sudden rush of alternative capital into the space see traditional reinsurers ratings fare, we wonder?

Fitch Ratings report can be accessed via its website and is worth reading for more insight on the factors affecting reinsurers today and into 2014.

Expect much more of this type of commentary over the next two weeks as we move up to and through the Monte Carlo Rendez-Vous time of the year.

If this commentary on alternative capital in reinsurance is of interest we recommend you read our article from yesterday: Alternative capital a disruptive force in reinsurance.