Reinsurance stable. Rates to rise. ILS capital treading water: AM Best

The global reinsurance market outlook remains stable, thanks to positive pricing momentum, improved market discipline and rising demand, according to rating agency AM Best.

In its latest analysis of global reinsurance market conditions, AM Best notes that there are plenty of positives set to drive market growth and provide participants with a strong chance of improving their returns, while at the same time there are some negatives that may weigh on certain segments of reinsurance more than others.

Positively, AM Best believes that demand for reinsurance capacity is rising.

Part of this is down to “primary carriers looking for stable results and capital efficiency in an uncertain environment,” AM Best explained.

At the same time, pricing is expected to remain positive in global reinsurance markets, with additional rate firming expected at the renewals in 2022, AM Best believes.

However, the rating agency does feel that rate increases may be slower in 2022, in certain areas of reinsurance.

This is likely due to the compounding effect of multiple years of rate increases that have now been achieved.

But still, “Unfavourable loss cost trends and high catastrophe activity continue to dampen returns on capital,” Am Best said, adding that this should, “Keep the industry focused on the need to push for more rate increases.”

Interestingly though, AM Best warns that rate increases in catastrophe lines of business may disappoint, “where the presence of alternative capital continues to mute pricing gains, to a degree.”

Once again, it has to be said here that ILS markets are very focused on achieving rate increases in collateralized reinsurance and retrocession, while the more named peril focused catastrophe bonds are seeing far tighter pricing execution.

That is to be expected, given the different product types and it is really important to look at the major globally diversified reinsurers when trying to identify where capital is coming from that is really dampening rate increases.

AM Best explains that, “In the absence of better investment options emerging, AM Best does not expect third party investors to pull back broadly from the natural catastrophe reinsurance market.”

Catastrophe bond market capacity remains “significant” the rating agency said, despite the impact of losses and trapped capital.

AM Best notes that third-party and ILS capital has exhibited “wariness” in the face of loss activity, loss creep, social inflation and trapped collateral issues in recent years.

“Third-party capital is treading water in late 2021 and likely into 2022,” AM Best said.

But the rating agency does not expect the market to shrink significantly.

At the same time, AM Best does expect ILS investors to elevate their return-on-capital requirements, in the face of continued high catastrophe losses, uncertainty over how climate change is playing into that, as well as challenges over longer claims settlement and loss amplification trends.

This, “Should result in higher demand for returns on capital from not only third-party capital providers, but also rated reinsurers,” AM Best explained.

Which should be positive for at least sustaining rate increases, even if they do not rise as substantially as some would like.

“Rates have been rising for almost five years now, with little sign of abating, so the industry is enjoying rate-on-rate compounding,” AM Best said.

But noted that there is no guarantee that they have risen sufficiently to trigger significant new capital deployment at this time.

Importantly, AM Best also highlights that ILS investors have a range of opportunities to generate returns on their capital, with reinsurance being just one of the alternative asset classes available to them.

As a result, the state of financial markets and the market cycles are also key, in how enticed institutional investors may be to deploy more capital into insurance-linked securities (ILS).

“Third-party capital providers will also have to contend with whether the low interest rate environment and buoyant stock market—including alternative assets (particularly private equity and real estate)—will result in significant opportunity costs over the next few quarters,” AM Best explained.

While ILS and third-party reinsurance capital may be treading water, that is certainly not true in all segments of the market.

The catastrophe bond market is on-track to break almost all its records in 2021, with the end of year issuance total now looking set to be significantly above previous highs.

The appetite of ILS investors for more predictable and transparent named peril focused reinsurance investments should continue to drive capital to that market, while the benefits of liquidity and disclosure will also help to attract more investors.

At the same time, some ceding companies are having a lot of success with bringing third-party capital into their own businesses, with their managed ILS funds, structures, sidecars and other vehicles.

There are also lower-volatility collateralised reinsurance funds that have done surprisingly well over the last few years and these stand well-positioned to continue their growth.

So, yes, a period of treading water is likely for some time, but ILS capital will continue to reorganise itself and reposition towards the structures and fund managers that have performed best and delivered the most predictable results, we believe.