Reinsurance pricing is unlikely to change its course in 2017, with further declines in anticipated and the soft market environment likely to be prolonged as the bottom of the market remains elusive, according to Fitch Ratings.
Premium rates at reinsurance renewals are expected to keep declining through 2017 with the market characterised by “large volumes of under-deployed capital and sluggish demand from reinsurance buyers,” the rating agency said today.
This comes on the heels of a number of years where global catastrophe activity has only been around the average, and even if the cost to insurance and reinsurance players increases to historical averages that won’t be enough to change the pricing trajectory and harden the reinsurance market, Fitch believes.
The “abundance of capital in the sector” is set to continue to weigh on pricing, Fitch believes, and this will mean that a significantly above average loss year would be required for pricing to move significantly.
Even 2016, when catastrophe insurance losses reached their highest level since 2012, has not been sufficient to cause any hardening of prices.
As a result of the continued softening, Fitch expects that reinsurance profitability will continue to wane, which it says is reflected in the continuation of its negative outlook for the sector.
In 2017, Fitch believes that reinsurance profitability will be eroded further, with the combined ratio (accident year and excluding catastrophes) forecast to rise to an average of 92%, up from 91.5% in 2016.
However, the majority of reinsurers are likely to continue to remain profitable, Fitch believes, with capital above their rating guidelines.
But the prospects for the wider market are looking gloomier, with Fitch now warning that some smaller reinsurance firms are at risk of negative rating actions if pricing drops much further, as their lack of diversification within their business models means they do not have any other levers to pull as pricing continues to decline and this erodes their profits.
The bottom of the reinsurance market price cycle remains elusive, Fitch says, explaining that it “Expects pricing conditions to remain challenging at the mid-year 2017 reinsurance renewals.”
Any further “material” declines in reinsurance prices could herald the start of negative rating actions on some reinsurers, as “Current pricing levels are approaching the cost of capital,” the rating agency warned today.
Rate declines at the mid-year renewals are expected to continue in the mid-single digits, Fitch forecasts, as “surplus capacity puts additional downward pressure on premium prices.”
The alternative market will be putting additional pressure on reinsurance pricing at this mid-year renewal, as evidenced by the pricing and upsizing of recent catastrophe bond transactions which show the ILS market becoming increasingly competitive on a price basis for some reinsurance layers.
This could result in a more competitive June and July 1st reinsurance renewal than even last year, as traditional reinsurers need to fight back to maintain their portfolios and the ILS and collateralized reinsurance markets wield their newly upgraded pricing efficiency.
It’s really a forecast for more of the same, but like other agencies and observers Fitch suggests that the calls for the reinsurance market cycle to bottom-out may have been made too early, as it looks like pricing is not going to completely stabilise quite yet.
The expectation of continued pricing pressure could bring back a desire to stretch terms and conditions for cedents, as a way to secure business and as pricing drops further and further the temptation to be less rational on underwriting will no doubt return.
The longer pricing is depressed and companies with higher cost-of-capital continue to underwrite, the greater the chances of discipline slipping.
Cost-of-capital is going to be key and, while pricing remains at or near lows, we could be on the verge of seeing an interesting dynamic emerge, where third-party capital and the capital markets have a true advantage, resulting in much greater use of alternative capacity.
For those with a lower cost-of-capital, such as ILS players, it’s important to know when to stop and where your bottom of the market should be.
For those with a higher cost-of-capital, such as many traditional reinsurers and players in markets such as Lloyd’s, the time to stop may have already come and gone.
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