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Still too early to call for bottom of the reinsurance cycle: Deutsche Bank


Those calling for a bottom to the reinsurance market cycle and an end to the persistent softening trend seen over the last few years may be disappointed, as analysts from Deutsche Bank join those suggesting further rate declines could be seen at the January 2018 renewals.

Reinsurance softening continues, price floor elusiveThe bottom of the reinsurance market price cycle has proven to be particularly elusive. As long ago as late 2015 some of the major reinsurers began their calls for the softening to slow and the bottom of the market to be on the verge of coming into view.

That hasn’t been the case. There’s a lot going on here and we try to give a little context, some ideas for where this is heading, how markets may respond, and more in this piece.

Softening continued at the all-important June 1st 2017 reinsurance renewal, with reports suggesting rates declined as much as -10% for some accounts, with a more widely seen -4% to -8% decline across much of the rest of the market, particularly on Florida property catastrophe programs.

Add that to the property catastrophe reinsurance rate declines seen over the last few years and pricing is now in many cases 40% lower than four years ago, in some cases even more.

Equity research analyst Frank Kopfinger from investment banking group Deutsche Bank’s Markets Research unit writes that reinsurance pricing is expected to fall at the July 1st renewals, with our sources in the market already suggesting that similar levels of price decline to those seen in June are likely to be seen.

Following these mid-year reinsurance renewals, and after much of the market takes a breather through the height of summer, thoughts will turn to the January 2018 reinsurance renewal, with negotiations that begin in Monte Carlo likely to set the tone for the rest of the year.

“The key question going forward will be whether this will really be the bottom now or whether prices continue to drop further at small rates as long as the sector is not hit by events bigger than last year’s hurricane Matthew,” Deutsche Bank analyst Frank Kopfinger writes.

“We are inclined to expect the latter, i.e. as long as natcats remain within budget, local events like cyclone Debbie or even bigger US hurricanes remain digestible, we do not see significant changes to the current oversupply and demand imbalance,” he continued.

The effects of excess traditional reinsurance capacity, plus growing insurance-linked securities (ILS) fund and investor capacity, as well as an increasing volume of third-party capital in different vehicles from sidecars to total-return reinsurers, means there’s no lack of capital in the market.

With losses remaining within budget for the major reinsurers, the smaller players and the ILS fund market over the last twelve months, there is little sign of a stimulus for change, which helps to ensure that the elusive pricing floor remains just out of reach.

But the margins for further price declines are slimming, with price adequacy at the major global reinsurance firms not far off breakeven, while for some other markets price adequacy across their portfolio may be just adequate, but on property catastrophe exposed lines it has already passed the point of un-profitability.

Surely this means there can’t be much further to go, as even the very largest reinsurance company cannot continue to support near-breakeven pricing if rates drop further, at least without perhaps revisiting their habit of discounting for diversification’s sake.

In fact price adequacy at some major reinsurers is expected to drop further, with others hovering just above the breakeven point at the July renewal and perhaps in January as well.

Should January 2018 see a price decline of even -3% to -5% it seems likely that some reinsurers could begin to decline much greater quantities of business again, resulting in even more excess capital to be returned if they cannot find anything else profitable to do with it.

“In the absence of major losses, we put a higher probability to a slow-burning softening going forward than to a real stabilization,” the analysts continue.

But this continued softening will not have a huge impact on combined ratios and underlying for the big four reinsurers, they say.

Yet. So that suggests there is still further to go before the largest players will have to shift significantly, which could mean further pain for mid-sized players and markets like Lloyd’s of London, for who the major reinsurance firms are key competition.

Looking ahead, Kopfinger writes; “After July renewals, the focus will quickly shift to Monte Carlo discussions in September and the January renewals,” but he adds that “We believe it is too early to call for the bottom of the market and we remain cautious.”

Clearly a really major catastrophe event could provide some solace, in the form of increased rates, but even here the analysts remain cautious.

“A major event would certainly help separate the strong from the weak and, in a second step, we have to see whether inflowing capital from the sidelines, from the major reinsurers themselves or from a company like Berkshire, would dampen any post-event price surge,” they wrote.

But if losses are within the budgeted levels that reinsurers allow for, Deutsche Bank’s analysts; “See the risk of further deteriorating price levels.”

Further up this article we referred to “discounting for diversification’s sake” a tactic we’ve seen more of over the last few years, as globally diversified re/insurance players wield the diversity of their books in order to keep pricing artificially low in some regions of the world.

This has had the effect of preventing the ILS fund and collateralized reinsurance markets from moving wholesale into some regions, for example it has all but finished the European windstorm cat bond market, with very few EU focused single peril deals now seen, as traditional coverage is so cost-effective.

The same has been seen in regions like Japan, Australia, South America and more, as traditional reinsurers retain market share with price reductions, often using these regions as diversifiers for their U.S. exposure.

But here’s a thought that could be positive for the ILS market going forwards.

ILS fund managers are largely still making returns in the U.S., even with the softened state of reinsurance pricing. At the same time they are actively looking to enhance margins through shifts along the risk-to-capital chain, or other initiatives.

This means that even if the traditional reinsurance market wants to push rates up in the absolutely key U.S. and Florida markets, the ILS funds and also catastrophe bond investors do not necessarily have to support that objective.

So if traditional reinsurers cannot make better rate in the U.S. and peak cat perils, where could they?

How about a slow and steady increase of reinsurance rates in the main diversifying regions of the world? There appears room to move on price in those regions, in some cases even taking rates back to a risk commensurate level could add 1 or 2 points of return to the average major reinsurers regional portfolios.

That would allow the reinsurers to remain competitive in the U.S., which could be vital for some players, but at the same time any increase in rates for diversifying regions could let more of the ILS market and its alternative capital in.

A quandary could be coming for major reinsurers, with decisions needing to be made about where to push for rate increases and equally where to remain competitive. Decisions that could have the potential to drive opportunity for the ILS market going forwards.

As we’ve written previously, the old concept of getting paid back for paying clients claims during the bad times seems increasingly old-fashioned, in these days of advanced technology, rapid capital movement and sophisticated risk transfer technology.

So if reinsurers need to get paid for taking on and bearing risks, not for paying claims, which seems aligned with how the market is developing with alternative capital and InsurTech, then the importance of charging risk commensurate pricing at all times could become key.

This may provide some insight into where and how the reinsurers of the future will get paid. It won’t be for playing the diversification game and then demanding massive rate increases when the worst happens. It will be for being the best at risk sourcing, analysis, pricing and structuring, all of the traits that actually see them using up their intellectual capital.

What does that mean for reinsurance pricing levels right now? Well that depends on whether the rates being charged are based on an accurate and up to date view of the risk, or whether rates really are too low to be sustained.

Deutsche’s analyst forecasts for reinsurance renewal pricing; “Even if January 2018 is the trough, we see no good reason why it should significantly move upward from there.”

Overall there are so many factors playing into reinsurance pricing right now that it really does feel like we’re still at the beginning of a new market cycle, not nearing a turn or any kind of correction (unless of course it’s risk commensurate).

The whole reinsurance market cycle may never be the same again. Companies need to accept this, be nimble and ready to adapt to how it does change in the future, add efficiency – all over their business models, and accept that the traditional reinsurance model may not always be the best model to back every kind of risk going forwards.

Change has been coming for so many years that those who havent’ foreseen it can be blamed for being complacent. It’s now time to change, before it’s too late (for some).

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