The global reinsurance market remains pressured due to overcapacity, stimulated by a lack of large losses causing excess capital among traditional reinsurers and the continued inflow of alternative capital, meaning the competitive pressures are likely to increase, according to EIOPA.
Europe’s insurance and reinsurance sector watchdog, the European Insurance and Occupational Pensions Authority (EIOPA), once again warns that overcapacity remains a threat to reinsurance sector profitability in its latest financial stability report.
However, the regulator has also continued its trend of being increasingly positive on the capital markets entry into reinsurance, a change in tone noted across the last few years, and in this years report EIOPA highlights that “substantial capital markets capacity” is (of course) also a factor that has helped traditional reinsurers to maintain their strong capital levels.
Strong capital levels is of course positive in any industry, it’s rarely seen as negative for an industry to be awash with cash. However, in reinsurance due to the competition from non-traditional or ILS backed players, traditional reinsurers are finding life more difficult even when capital levels are higher.
While EIOPA notes that reinsurers capital levels are strong, helped by the low incidence of major catastrophe losses and the availability of capital markets or ILS capacity, it also notes that reinsurance pricing remains depressed.
However, EIOPA also notes the trend seen at recent renewals, that pricing declines have slowed across the reinsurance market, although the regulator also notes that “prices have not yet found their floor.”
As a result, profitability is under pressure in reinsurance, EIOPA notes, with subdued demand for coverage, due to greater retention at primary insurers, occurring at the same time as excess capacity. Some limited increases in demand for reinsurance may occur post-Solvency II, EIOPA notes.
“Altogether, the competitive pressure in the reinsurance sector will increase further,” EIOPA predicts.
Continued inflow of capital is expected, which when combined with benign catastrophe activity, reduced investment returns, an expected diminishing of the ability of reinsurers to release reserves, the softened market, and lower profitability of long-term business, all adds up to ongoing pressures and heightened competition.
Against this pressured background, it is crucial that reinsurance firms achieve risk adequate pricing at renewals, EIOPA said. Of course it is widely understood that in many markets this is achieved, but the diversification benefit in non-peak or diversifying catastrophe zones means that large reinsurers are writing risk at very low returns.
EIOPA notes that alternative capital from insurance-linked securities (ILS) and collateralised reinsurance vehicles continued to grow even at a time when traditional capital reached excess levels and shrank a little.
“Third party capital is expected to continue to enter the market as large pension funds and hedge funds search for ways to diversify their portfolios while chasing for higher return,” EIOPA explained.
Citing Artemis, the regulator noted that forecasts that ILS vehicles may shrink through 2015 proved not to be true, with growth seen across the vast majority of the alternative capital markets.
With investor comfort of indemnity triggers growing all the time and spreads tightening between different triggers and structures, the attractiveness of ILS is expected to rise for both new and repeat sponsors, EIOPA explains.
And sponsors are expected to continue to issue ILS, “not only to diversify and complement overall reinsurance purchases, but also to benefit from the alternative competitive pricing and broadening indemnity coverage.”
EIOPA also notes the other important area where additional competitive pressure is set to emerge, as well as increasing pressure to become efficient and to reduce the cost of underwriting capital, insurance technology or Insurtech.
To date, EIOPA notes accurately that the vast majority of insurtech initiatives are focused on enhancing, improving or smoothing existing processes, or putting a veneer of customer and user experience design on legacy systems and processes.
“So far, most insurers put a focus on optimising existing tools instead of significantly reviewing and transforming their business models,” EIOPA comments.
However, EIOPA agrees that over time technology and the insurtech wave will cause “profound change in the industry in the coming years by disrupting traditional business models.”
Among these threats from insurtech, one of the most imminent is the “disintermediation process”, EIOPA explains. New distribution methods, peer-to-peer, pooling of risks and insureds, group buying and smart contracts are all business models which are set to disrupt the insurance and reinsurance market.
Embracing these disruptive methods will help reinsurance capital providers, be they traditional or alternative, to shift their capacity up the risk to capital value-chain, reduce intermediation costs, directly assume primary risks on an aggregated basis into large portfolios and generally find more efficient ways to originate, structure, aggregate, invest in and transfer risks.
If reinsurance pressures are set to increase further due to overcapacity, the drive for efficiency and proximity to risk which has been started by alternative capital and is set to be accelerated by insurtech, will both ramp up that pressure for some, but also perhaps alleviate it a little for those embracing insurtech innovation.
As trends in both insurance and reinsurance continue to converge on a new market paradigm where efficiency of operations and risk capital are both key, the capital markets and insurance technology could find themselves the largest disruptors of incumbents.
Meaning that the incumbents who embrace efficient capital, efficient mechanisms to source and transfer risks and insurtech are the ones most likely to prosper meaningfully against agile startups and the threats they pose.
It’s encouraging to see that some of the largest ILS managers are well aware of the need to stay ahead of these trends and are positioning their efficient capital as close to as many sources of risk as possible.