Analysts at Deutsche Bank have warned that even a mega industry loss event might not be enough for reinsurers to sufficiently push up pricing due to capacity and capital, further evidence of the flattening of the market cycle.
Global reinsurance capital stands at an estimated $565 billion of which alternative capital makes up approximately $72 billion, says Deutsche Bank citing data from reinsurance broker Aon Benfield in a recent report.
The report explains that since 2012 the volume of alternative reinsurance capital in the space has tripled from $24 billion to the level reported today, and although there has been a slowdown in the influx of third-party capital into the industry in recent quarters, it is expected to continue entering the space as a permanent source of capacity and to continue growing its share.
The record level of total, global reinsurance capacity reported by Aon Benfield at a time of benign losses (although cat losses have picked up somewhat in the first-half of 2016) coupled with a lack of demand, has resulted in an overcapitalised marketplace where buyers of protection are able to benefit from favourable rates and terms.
In response, reinsurers have been waiting for the next big event to remove some of the abundance of capital in the sector, enabling them to push up rates, ultimately bringing an end to the softening market cycle.
However, according to Deutsche Bank the excess capacity in the space and the abundance of both traditional and third-party reinsurance capital sat on the sidelines waiting to enter the market after the next large event, suggests a much smaller price surge post-event than in previous years. Even in the event of a 1-in-200-year U.S. hurricane.
Regarding alternative capital, Deutsche Bank said, “As long as rates stay low, we see no reason why investors should be scared away from this market segment, as it should offer new investment opportunities. We simply expect a shift, with capital that just got hit from the hurricane loss staying away, while new money flows into the market.”
“We therefore expect that any price surge following a mega event would be smaller this time, and it remains to be seen whether this would be sufficient to re-coup the losses,” continued Deutsche Bank.
Historically, after a large loss event demand surges and prices rise, enabling reinsurers to earn back losses from the event that took place and achieve more desirable rates.
But with a high volume of alternative reinsurance capital sat on the sidelines, and also the strong capitalisation of the large traditional players operating in the space, such as Munich Re, Swiss Re, Hannover Re, Berkshire Hathaway’s National Indemnity/GenRe, and SCOR, any price surge could be substantially reduced.
In Deutsche Banks view, Swiss Re would stand to benefit the most from any surge in pricing following a mega natural catastrophe because it has the highest exposure to nat cats, “and therefore should have the best starting position to benefit from a post-event price increase.”
But, overall, “We believe that the strong capitalization even after a big event will be one the reasons why, following a big hurricane, prices might not see the same hikes as after previous events, e.g. after hurricane Andrew in 1994,” said Deutsche Bank.
Since the volume of third-party reinsurance capital really started to influence the marketplace and expand to a meaningful size, numerous industry experts and analysts predicted that the traditional market cycle would likely be much flatter in the future, where peaks and troughs will be less dramatic.
Deutsche Bank expects a similar trend to occur with the reinsurance market cycle post-event, with alternative and traditional capital combining to continue to drive sector disruption, ultimately resulting in structural lower but more stable reinsurance pricing.
Discussing the reported wealth of capacity waiting to enter the space, Deutsche Bank highlights Berkshire Hathaway subsidiary National Indemnity/GenRe as an example, citing the admission from the firm that should the sector experience a $250 billion event, for example, Berkshire would “remain awash in cash and be looking for large opportunities to write business.”
Furthermore, despite the ILS market being largely untested in the face of a large loss event, investors now have an increased sophistication and understanding of both the underlying risks and the benefits of investing in the space. This could see those same investors recapitalise and look to redeploy in the diversifying, uncorrelated asset class or, new ILS investors enter the market to fill the gap and take advantage of any surge in pricing, albeit moderated.
So with re/insurers like Berkshire Hathaway seemingly able to deploy vast amounts of capital into the sector following a mega loss event, the strong capitalisation of reinsurers like Swiss Re and Munich Re, and the expected permanence and persistent inflow of ILS capital, it’s not too surprising that Deutsche Bank expects a price surges of a smaller magnitude.
The report estimates that a 1-in-200-year U.S. hurricane event would cause an economic loss of up to $250 billion, and an insured loss of $150 billion, resulting in the removal of 10% to 15% of overall traditional capital.
But owing to the factors mentioned throughout this article, Deutsche Bank “questions whether even a cut of industry capacity by 10-15% would be big enough to lead to any meaningful price surge in the aftermath of such a big hurricane.”