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Reinsurers still “in the eye of the storm” – RBC Capital Markets


RBC Capital Markets feels it’s too early to hold a positive stance on the European reinsurance sector as rates are expected to continue declining into 2017 and the potential for catastrophe losses persists, with hurricane Matthew highlighting the significant impact such an event could have on the market.

Despite reports of rates reductions slowing and even stabilising in some reinsurance business lines, analysts at RBC Capital Markets (RBC) feel it is far too early to become positive on capital returns for the reinsurance sector.

This is for two reasons, explains RBC, with the first being the ongoing Atlantic hurricane season, which, as shown by the recent impact of hurricane Matthew still has the potential to produce a significant event in 2016. Secondly, analysts at RBC predict further, smaller rate reductions in 2017, compared with the expected consensus that pricing will remain flat.

“Despite reinsurance management teams arguing for flat pricing heading into 2017, we believe the upcoming January renewals will yield further single digit declines, a more negative view than consensus expectations of stable pricing,” explains RBC.

Reinsurers are finding it increasingly challenging to remain profitable absent prior year reserves and the relatively benign loss experience, a trend that has resulted in normalised combined ratios moving ever closer to the 100% threshold.

Despite combined ratios threatening to move beyond 100% and into unprofitable territory, RBC explains that record levels of capital in the sector and its analysis that compares ROEs to the five-year risk free rate, suggests that a pricing floor is yet to be reached, with little sign that this will happen in the near-term.

RBC’s analysis reveals that the average reinsurance ROE above the average risk free rate for 2017E is 8.1%, a decline from the 8.4% for 2016E, and further still from the 11% recorded in 2014. However, in order for pricing to begin to turn in a meaningful way, RBC states that this needs to drop to around 5%, which was last seen in 2011, when the last significant pricing correction took place in the sector.

“The major problem that the industry has is that the glut of capital that has built up in both traditional and alternative markets has shown no signs of going away. This record level of capital has been a major cause of pricing reductions in our view. Without a shock capital market or catastrophe loss, we see little sign that pricing will turn meaningfully in the near term,” says RBC.

Alternative reinsurance capital continues to expand its presence in the global reinsurance market, and absent an event taking place of the magnitude to remove a substantial amount of capacity, it’s hard to see the sector start to move away from its softening phase in the near-term.

That being said, and with the Atlantic hurricane season still underway and ROEs being under pressure, RBC feels that a large loss event (perhaps a significant landfalling U.S. hurricane) could see the sector’s ROE above the risk free rate move closer to 5% more easily than in previous years, which the firm reiterates could see the market start to turn.

For a period it looked as though hurricane Matthew was set to make landfall along the Florida, U.S. coast, and that insurers, reinsurers, and ILS players were likely to experience significant losses. However, the track and strength of the storm meant that the insurance and reinsurance industry loss estimate for the event has been suggested at up to $6 billion, which is far from enough to result in any turn in pricing.

While the analysis from RBC suggests that a significant event could see ROEs above the risk free rate move closer to 5% and drive a turn in the market, it’s important to remember that reports suggest that ample capacity, from both traditional and alternative sources, is sat on the sidelines waiting to enter.

This could limit any price-surge post-event that the industry has been used to during previous cycles, which highlights the difficulty in trying to predict what might cause a turn in a market cycle that has been exacerbated by unprecedented inflows of capital and a lack of losses.

So far, losses in 2016 have been higher when compared with more recent years, underlined by the devastating wildfires in Canada and earthquakes in Japan and Ecuador.

With reserves reportedly running thin across the sector and reinsurers increasingly struggling to bring down cost-of-capital levels at a time of limited profitability on both sides of the balance sheet, a large hurricane event in the final months of the year could really test the resolve of some in the space.

Only time will tell how the market reacts after the next large loss and whether the capital sat outside the space ready to enter will seriously flatten the market cycle moving forward. But the message from RBC is clear, expect further rate declines in 2017 and ROEs to continue falling, but perhaps not quite enough to turn the market, unless a substantial event takes place.

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