The share prices of leading publicly traded reinsurance companies, including the top four European reinsurers, have suffered during the first-quarter of 2014 as the abundant levels of traditional and alternative capital put pressure on reinsurance rates.
Rating agency A.M. Best said that reinsurance stocks have suffered and underperformed the wider stock market during Q1, declining by 1.3%, with the concerns over the pricing of reinsurance risk likely to be the leading cause of this drop in share prices.
A.M. Best highlights, in a recent report, that during the first three months of the year global reinsurance companies experienced below-average catastrophe losses and the majority continued to experience favorable loss reserve development, so why the decline in share prices?
It all comes back to pricing pressure, believes A.M. Best. Regardless of low losses, improving reserves and profitable results, investors in reinsurance companies are clearly aware of the price declines in reinsurance pricing and are treating reinsurer stocks with caution as a result.
With reinsurance prices having declined at all of the major reinsurance renewals this year, the latest being another 15% to 25% decline in Florida property catastrophe reinsurance at June 1, the effects appear to be felt by reinsurers share prices which give some sign of investors confidence in these firms ability to continue to produce the profits seen in recent years.
The impact of third-party reinsurance capital and insurance-linked securities (ILS) is a factor in the declining prices, although it cannot alone be blamed for driving prices down so far as traditional reinsurers are in many cases leading this push. It is the competition that has resulted from an inflow of capital markets money into ILS, which has stimulated reinsurers to compete more strongly and relax terms more aggressively, which have combined to drive down prices in the low-loss, high-capital market environment.
The continued interest of new capital in the reinsurance market, combined with reduced reinsurance purchasing by some large cedents are expected to make market conditions increasingly difficult for reinsurers in 2014, said A.M. Best. Continued pricing pressure is expected in property cat lines, but this is also spilling over into other areas of the market, meaning there is nowhere for traditional reinsurers to hide and attempt to secure higher priced business anymore.
Continued pressure is also expected on quota-share ceding commissions, resulting in more multi-year contract investigation, broader contractual terms being negotiated and increased signings featuring aggregate covers, said Best.
Despite all this, reinsurers expect to remain reasonably profitable at least in the short-term. Companies intend to pull-back on property cat as prices continue to decline and remain selective about the risks they write. Risk selection continues to increase in importance, as does large reinsurers ability to move focus to primary business although that too is beginning to feel the pressure of the market environment.
Third-party capital is expected to continue to flow into the reinsurance market through 2014, said A.M. Best, as large pension funds and hedge funds continue to see reinsurance as an attractive diversifying alternative asset class. Pricing is expected to remain under pressure, particularly on U.S. reinsurance lines with property cat business remaining the most competitive.
A.M. Best believes that despite all this the market will remain largely disciplined and will not chase premiums, preferring to work to strengthen their financial positions in the market. This is certainly the case in the majority of reports on renewals, however some reports of prices being chased down and terms being relaxed ever further are coming to light.
Finally, A.M. Best notes that as capital levels continue to rise, competition continues to ramp up and reserve releases decline, the ability to generate returns will get increasingly challenging. This is something that all sides of the market, traditional and alternative, are going to have to come to terms with and find a way to navigate through. This is when mergers and acquisitions will look most attractive, both from buyer and seller side, something that may become an increasing source of news in the months ahead.
Reinsurance share prices could find themselves under increasing pressure should large, institutional holders decide that there might be better ways to access the return of the reinsurance market than by investing directly in reinsurer equity. With options to invest in the reinsurance industry expanding all the time, there could be a real risk that other insurance linked investment structures, such as ILS, sidecars, hybrid asset manager backed reinsurance firms that outperform the market or reinsurance funds, begin to take an increasing amount of the capital that was once dedicated to reinsurance stocks.
Maybe that goes some way to explaining the growth in reinsurer sponsored third-party capital and ILS units?