Executives from global ratings agency Standard & Poor’s have underlined the growing influence of ILS capital in the global reinsurance landscape, a marketplace where ROEs are expected to continue to deteriorate as headwinds persist.
Speaking with Artemis at the Monte Carlo Reinsurance Re, an annual meeting of the reinsurance industry, S&P discussed the current state of the global reinsurance market and what the future might hold, including the growing influence of the insurance-linked securities (ILS) space.
In recent times the flood of alternative reinsurance capital has continued to deepen its relationship with the insurance and reinsurance industry, resulting in more and more reinsurers embracing the features of the ILS space, a trend highlighted by Dennis Sugrue, Senior Director, Insurance Ratings at S&P.
“This is already widespread, at least in terms of count, as nearly all of the reinsurers we rate are utilizing alternative capital in some way. However it is unclear how much more alternative capital reinsurers will use in order to lower their cost.
“We see that demand for ILS capital is slowing, as indicated by the slower growth rates of capital in 2015 and 2016 to date. So the opportunity to expand this avenue for capital may be drying up for reinsurers in the current market,” said Sugrue.
It’s an interesting point, and highlights how reinsurers, for the most part, have moved away from seeking to compete with the expanding ILS space and instead sought to work with it, utilising its features to supplement and support their balance sheets.
The growth of alternative capital has slowed in recent times when compared with previous years, driven by declining rates in the property catastrophe space, the most common area ILS capital plays, and also third-party investor discipline.
The global reinsurance market remains awash with capital from both traditional and alternative sources, a factor that along with the benign loss experience, low interest rates and other headwinds, has seen the deterioration of reinsurance ROEs, something Sugrue expects to continue.
“We expect a continued deterioration in reinsurers’ ROEs over the next two years as pricing will continue to decline, expenses continue to rise, investment returns will remain paltry and reinsurers’ string of luck may soon run out and benefits from benign catastrophe losses and significant releases may dry up. We forecast an industry ROE between 7-9% in 2016 and 2017; well below the 10 year average of nearly 13%,” said Sugrue.
Furthermore, Sugrue expects the softening of the global reinsurance landscape to persist into 2017, predicting further rate declines for the space.
“We anticipate that the softening pricing will continue into 2017. We estimate average rate declines for the year of 0-5%, with some divergence between lines and regions. We surveyed the 150+ audience members of our webcast on Wednesday of this week and 56% felt that rates would decline between 0-2.5% next year and 28% expected 2.5-5% declines so they seemed to align with our expectations,” said Sugrue.
S&P also provided some insight into what the future of the ILS market might hold, and Maren Josefs, Associate Director, Insurance Ratings, said “we have seen an increase in ILS rating enquiries targeting new ways to improve capital efficiency for ILS funds and (re)insurers,” which was evidenced just last week in the rated private cat bonds issued by ILS fund manager Leadenhall Capital Partners.
“Regarding the ILS Market Prospects – I think the cat bond market will be slow as alternative capital is put to work. I believe it’s cheaper to purchase coverage this way (no issuance costs), and it’s fully collateralized,” added Gary Martucci.
A major talking point in the market, and a topic that will no doubt be discussed by many in Monte Carlo, is the benign catastrophe experience and how the market might react after the next large event. As noted by Sugrue, reserves could be drying up for some in the sector, and should a significant loss event take place it will be interesting to see how both traditional players and the ILS market reacts.
“It depends on the size of the loss. If it were a repeat of the 1926 Great Miami hurricane, (estimated industry losses in excess of $120 billion), and a lot of the capital was lost, then you could see some pullback in the amount of capital in the ILS space. That said, it won’t disappear. Generally, say after an Andrew or Katrina, we would expect prices to harden a bit but given the amount of cash on the sidelines waiting to be put to work, we would expect overall capacity to remain where it is.
“Investors will still like the diversification and the rates are relatively attractive, and will be more so after an event as rates harden. Additionally, depending on how much rates rise, you could see increased cat issuance since buyers would want to lock in rates for multiple years. We saw that after 2004 & 2005, rates jumped significantly in 2006 & 2007 when the market was much less developed and insurers wanted to lock in multi-year financing of their reinsurance costs,” explained Gary Martucci, Director, Insurance Ratings at S&P.
Discussing how the re/insurance sector might react after the next large event, Sugrue said; “We estimate that the reinsurance industry has sufficient capital to absorb a 1/250 aggregate net loss. Based on our capital model and the information provided to us by the reinsurers, we estimate that the industry has $59 billion of excess capital at the ‘BBB’ stress scenario ($93 billion at BBB, $45 billion at AA and $26 billion at AAA) and that a 1/250 event would eat up $58.5 billion of the industry’s excess capital. So in that scenario, the industry would still be capitalized to the ‘A’ level. However, 18 of the 21 reinsurers we rate would see their capital scores change, which could mean that their ratings could change.”
“We suspect that may have some impact on pricing over the short term, particularly in lines and regions that are most affected by the losses; but that it probably won’t lead to a widespread turn in the market as there is plenty of capital waiting on the sidelines to come in after a big loss. We expect that capital to flow in via alternative capital vehicles rather than a wave of start-up companies like we saw most recently in 2005 or 2002.”
As highlighted by a number of industry observers and experts in recent times, and discussed by us at Artemis, the excess capital in the sector and that sat on the sidelines waiting to enter, suggests that any price-surge post-event is likely to be limited.
The future looks set to remain challenging for global reinsurers, and the expectation of further rate declines and profit deterioration highlights the growing importance of discipline and efficiency. The ILS market will likely continue to expand its influence, but so long as reinsurers continue to embrace its features and capacity it could assist companies looking to navigate the softening landscape.
Our thanks to S&P’s executives for their time and insights.
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