With the mid-year reinsurance renewals fast approaching market participants are reporting that demand from traditional reinsurers for higher priced business, and from ILS investors for higher yielding layers of risk, are combining to squeeze returns on riskier program layers.
At a time when overall pricing and rates are expected to decline by as much as 10% across the reinsurance renewals, it’s becoming apparent that the stability being witnessed on some programs, in terms of year-on-year renewal pricing, is likely to be on the lower risk, lower yielding layers.
There is a general opinion in the market, among participants Artemis has spoken with in advance of the renewal, that where stability is being seen the most is on the more remote layers of risk. Here reinsurers see pricing nearing technical levels and it is considered impossible to squeeze risk spreads any further by capital market investors.
Additionally, demand from both traditional reinsurance firms and ILS fund managers and investors is focused on lower layers of risk, where the risk pricing or spread is considered more attractive. Having witnessed price declines at consecutive renewals, both reinsurers and ILS players are seeking out higher priced deals, which ultimately means taking on more risk.
Reinsurance broker Willis Re recently highlighted exactly this trend in a report, saying that it was noticing that “Investors seem keen to take more risk and risk spreads for riskier deals continue to compress.”
At the same time that the broker noticed heightened demand for riskier layers from capital market investors, it also noted on the more remote layers that “Demand is steady with risk spreads remaining in equilibrium.”
That backs up exactly what we hear from market participants in the run up to the June and July reinsurance renewals. That both traditional reinsurers and ILS managers or investors are increasingly attracted to higher risk layers, as they seek out enhanced risk adjusted returns.
It also backs up recent secondary catastrophe bond and ILS market trends, which have seen lower yielding bond prices decline in the last two months. The lack of attraction to some of these notes is partly responsible, as investors seek out better returns from higher risk deals.
With this in mind it’s likely that the greatest price declines at the mid-year renewals will be seen on the more risky layers of reinsurance programmes, while more remote layers have neared the bottom of both reinsurance company and ILS investor risk appetite, leaving little room for further declines.
Of course, whatever layer in the tower pricing pressure occurs it will further erode the natural returns that reinsurers have been making. As ILS players increasingly move into the more working layers of reinsurance programmes the impact to traditional players continues and will grow.
On the other hand, as ILS players display an increasing appetite for riskier layers of reinsurance programmes they will suffer more frequent losses as a result. That puts an additional burden on ILS manager resources. It takes people to manage claims payments under collateralized reinsurance as well as traditional contracts, ensuring that ILS team expansion will likely continue as well.
The competition looks set to move to higher risk layers as reinsurers and ILS managers look for better risk spreads from the business underwritten. That should accelerate the chances of stabilisation being witnessed in pricing across the spectrum of risks, rather than just at certain, less risky, layers.