The very soft retrocessional reinsurance market is beginning to offer savvy underwriters and protection buyers an opportunity to arbitrage the market, broker Willis Re explained in its January renewals report.
When reinsurance rates move so far and so fast as they have in recent renewal cycles opportunities to arbitrage the market can emerge, if the pricing of traditional reinsurance versus retrocession diverges to a degree. Willis Re believes that we are beginning to see a market environment that is conducive to this, which can enable underwriters to load up on risk with primary reinsurance deals and then to offload it to retrocession specialists at a cheaper cost, allowing them to profit from the arbitrage on pricing.
Of course this isn’t always advised to be a very sound practice or strategy, in terms of sustainable underwriting, but it is yet another sign of the new low’s we are seeing in reinsurance and retrocession pricing, as a result of the continued influence of excess and alternative capital on the reinsurance market.
Surplus levels of both traditional and alternative reinsurance capital combined with another benign year for losses in 2014 have led to additional price reductions in non-marine retrocession, according to Willis Re, causing it to refer to the retro market as “very soft”.
At the January reinsurance renewals retro protection buyers have been able to tailor their buying with a further move towards worldwide, aggregate, pillared and composite programs. Willis Re noted that both peak risk or worldwide retrocession covers, as well as regional retro programs have enjoyed double-digit reductions in pricing at January 1st.
Interestingly, Willis Re says that aviation retrocession pricing has remained stable, with capacity plentiful. This is perhaps surprising with the losses suffered by the aviation market in 2014, but also reflects the abundance of capital and appetite for risk from traditional markets and ILS investors focused on retrocession. Some moderate pricing reductions have been witnessed.
Willis Re’s renewal report also notes that personal accident or life catastrophe reinsurance retrocession rates have begun to soften, having remained firm for the last two renewal seasons. These lines saw reductions of around 10% at the renewal, showing that the influence of capital is spreading to other areas outside property catastrophe risks in the retrocession market.
Industry loss warranty (ILW) volumes have held up at the renewals as attractive pricing alongside the ease of purchasing and deploying these contracts continues to generate interest in this simple form of industry loss based risk transfer. ILW’s often benefit as buyers seek to capitalise on attractive rates, or when they look to arbitrage an ILW can be a very quick to execute form of retrocession that provides a broad protection which responds to the largest loss events.
There are no indications of any slowdown in investors seeking access to reinsurance and retrocession as an asset with low-correlation, despite the overall returns falling, Willis Re says. This appetite is helping to soften retro rates further as it is now a market largely backed by third-party investors and the capital markets.
The arbitrage opportunity that is emerging due to softened retrocession rates enables reinsurers to keep supporting their clients in a price-competitive market, Willis Re says. Whether the opportunity remains for long will depend on how traditional reinsurance rates follow retro rates down.
The softer retrocession market could also reflect pricing in the catastrophe bond market, where some of the capacity is deployed into retrocessional deals. It will be interesting to see whether there is an uptick in reinsurers issuing catastrophe bonds in 2015, as they seek to take advantage of cheaper capital from investors and lock-in retrocessional coverage using securitization.
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