Pressure on profits in the reinsurance market is increasing as excess capacity, declining demand and “non-abating alternative capital” contrive to reduce underwriting margins, something regulator EIOPA warns the market should expect to persist.
Europe’s insurance and reinsurance sector regulatory watchdog, the European Insurance and Occupational Pensions Authority (EIOPA), remains acutely aware of the threat posed by overcapacity to reinsurance sector profitability, reiterating the fact in its latest financial stability report.
EIOPA explains; “In the reinsurance sector, the demand is still subdued, whereas the reinsurance capacity continues to increase. The combination of the continuing capital-inflow into the reinsurance market, benign catastrophe activity and increasingly low investment returns due to the ongoing challenging economic environment increases the profitability pressure in the reinsurance business.”
“The general environment remains largely unchanged,” EIOPA said today, adding that “Market experts expect these trends to continue over the short-to-medium term, in the absence of significant deteriorations in underwriting loss ratios.”
Alongside the pressure on profits, EIOPA notes that while pricing has declined reinsurance buyers have continued to get more for their money in 2016, with terms and conditions for reinsurance placements improving all the time.
EIOPA anticipates competitive pressure will continue to increase in reinsurance, with a continuing in-flow of capital expected and reserves diminishing, while interest rates remain low and catastrophe loss activity relatively benign.
Risk adequate pricing is “crucial” at the upcoming January reinsurance renewal, EIOPA says, in order to ensure that the business underwritten can actually earn a profit, rather than be a drag on earnings.
EIOPA expects “a further deterioration in reinsurers’ return on equity,” even if the sector does experience just a normal catastrophe load. The market should not expect any solace if a large loss event does occur either.
EIOPA notes; “Given the amount of cash on the sidelines waiting to be put to work, even after a hurricane Katrina the overall capacity is to be expected to remain where it is.
“The reinsurance industry has sufficient capital to avoid insolvency from events that may occur once in 100 or 250 years (the so-called “probable maximum loss” or PML).”
While alternative reinsurance capital has risen to roughly $75 billion EIOPA notes that this does remain “modest” saying that “this might mitigate the risks stemming from building-up of tail risk.”
But EIOPA expects that interest in reinsurance and particularly catastrophe risks will continue, meaning that; “Low corporate and sovereign debt yields are likely to continue to produce more capacity for catastrophe and other reinsured risks.”
And this alternative capital is beginning to spill more broadly into reinsurance, EIOPA says, beyond solely non-proportional catastrophe business. This makes more room for capital to enter, increasing competition and pressure and forcing traditional capital into other parts of the market, in turn pressuring those lines.
As long as alternative capital investors continue to have an appetite for the low correlation and diversifying nature of investments in insurance and reinsurance risk this cycle of capital entry, competition ramp up, capital over-spill and jumping to other lines, will continue with the resulting increase in pressure on profitability more broadly.
Finally, EIOPA does not think that reinsurance pricing has found its floor yet, anticipating rate declines in the low single-digits into 2017 renewals. That will further erode profitability of new business underwritten, reducing further the chance to raise profits per unit of risk written.
The outlook from EIOPA remains gloomy, one of pressure on the traditional business models profitability, as it has done for the last few years. With pressure set to increase further, the competition will ramp up too, as should reinsurers use of alternative capital in areas of the market where they can no longer make the profits stack up.