Some underwriters in the insurance and reinsurance industry are writing risks for too low a return on their capital, as a “fair degree of undisciplined underwriting” was highlighted today by Jardine Lloyd Thompson Group Chief Executive Dominic Burke.
The reinsurance market has been challenging over the last year to 18 months, as excess capital from traditional reinsurers and new capital inflow from third-party reinsurance investors and insurance-linked securities (ILS) put pressure on rates across most lines of business.
JLT Group announced its results today, its first to include the newly merged JLT Towers Re reinsurance broking group. Brokers have been feeling the pressure of the market environment as well, with even the largest player Aon cited a slowdown in organic growth across its reinsurance broking business.
JLT Group actually reports 6% organic revenue growth, which is impressive from a developing brokerage platform which also includes an active capital markets and insurance-linked securities (ILS) focus at the JLT Capital Markets unit.
Burke acknowledged the challenging environment in the results statement; “We are confident that we can deliver year on year financial progress, but we are more cautious over the outlook for the remainder of the year given the marked decline in the insurance and reinsurance rating environment over the last quarter.”
During interviews with some news media outlets this morning, Burke explained that the decline in reinsurance pricing has led some underwriters to take on risk too cheaply, citing ill-disciplined or naive capital.
Burke told Bloomberg that some companies have been accepting a return on capital as low as 5% or 6%, in an effort to stimulate or to acquire growth and signings.
Bloomberg notes that this is almost half the usual return on equity that an insurer or reinsurer would look to earn by putting its capital to work. Given the cost of operating a re/insurer, this is a clear sign that some are putting their futures at risk by taking on risk at a return which is unsustainable (unless they are very lucky, we should add).
“If capital becomes either ill disciplined or naive, then it won’t be long before they lose their shirts. Underwriters are targeting or accepting lower return capital, and one has to question whether it properly reflects their risks,” Burke told Bloomberg.
Burke said what many now appreciate, that the way rates have declined and the reinsurance market has softened, is not simply a function of the normal reinsurance market cycle. Rather this is a function of excess capital at traditional players, forcing them to compete harder, as well as new and lower-cost sources of capital which exacerbate the pressure and ramp up the competitive environment even further.
Burke said that his JLT colleagues around the world report that this is a “unique” market environment.
This unique environment is now affecting everybody, from insurers to reinsurers and brokers. It is also affecting ILS funds and managers, as pricing dropped, showing that even the new capital is not immune from the competitive environment.
Again, the cost and efficiency of capital becomes increasingly important in such a market. Which means that underwriting risks at around half the accepted level of return could be extremely dangerous for a reinsurer. Over the coming quarters we will begin to see the impact of any such underwriting practice.