Reinsurers under pressure ahead of renewals season

In recent weeks the four major ratings agents have all affirmed negative outlooks for the reinsurance sector in 2015 as concerns grow over the direction of the market and the long-term impact of alternative capital. “Our view of the reinsurance sector is not rosy,” explained Dennis Sugrue, Director of Standard & Poor’s. “Supply has been increasing at a time when large global insurers are buying less reinsurance from fewer reinsurers,” he said. An S&P report in January warned that after some years of stability it was seeing negative trends for rated reinsurers. Competitive pressures have been piling up for the reinsurance industry, according to Mr Sugrue, who was speaking at a briefing this week ahead of this weekend’s Monte Carlo Reinsurance Rendez-Vous. Prices are down across the board, in particular for property catastrophe business in the US, Europe and Asia Pacific, as well as for other lines of business, he said.hideStorm losses, most notably from German hailstorms in the summer of 2013, helped European reinsurance prices hold up at January 2014 renewals. However rates will come under increasing pressure as traditional reinsurers reposition themselves follow-ing competition from alternative capital, said Martyn Street, an analyst at Fitch. “The last two years have seen significant price reduction for US property catastrophe reinsurance and some margins are approaching their technical floor. As the traditional reinsurance market looks to draw back from property cat we could see larger price declines in Europe and Asia at the January and April 2015 reinsurance renewals,” predicted Mr Street. “The question remains whether we will see the ingress of alternative capital into Europe and Asia,” he continued. Alternative capital players have so far preferred well-modelled and higher margin risks, such as US property cat, he added. As third party capital providers have moved into the property cat space, traditional underwriters have moved into new areas, such as emerging markets, crop insurance and accident and health, according to Greg Reisner, an analyst with AM Best. “There is also a spill over into casualty lines as reinsurers know that third party capital providers will not go there yet. Although the margins are thin, it is a place for them to go,” he said. For example, Lloyd’s is looking to expand into Europe and emerging markets as its traditional source of reinsurance business—US earthquake and windstorm—comes under pricing pressure from alternative capital, according to Stefan Holzberger, Managing Director, Analytics at AM Best. The market saw its reinsurance premiums fall 2% last year at a time when the total market grew 2%, he said. AM Best was the most recent ratings agent to change its reinsurance sector outlook from stable to negative. Although there are no immediate plans to downgrade the ratings of reinsurers, more negative ratings actions than positive are expected in the future, said Mr Reisner. Fitch also placed the reinsurance sector on a negative outlook in January, although its ratings outlook—which indicates whether the reinsurers it rates are likely to experience upgrades or downgrades—is stable. The negative outlook reflects ‘fundamental trends’ in the reinsurance market, including falling prices, sluggish demand for reinsurance and increased competition, including the ‘onslaught of alternative capital’, said Mr Street. However, despite price erosion, Fitch expects reinsurers’ profitability to remain adequate and capitalisation to stay strong. This is reflected in its stable ratings outlook, said Mr Street. Buyers of reinsurance can enjoy the best of both worlds in the current market, explained Mr Street. “Cedents can enjoy lower rates with no real concerns over reinsurers’ capital,” he said. However, pricing pressure will increasingly affect reinsurers’ ability to maintain current earnings and capital levels, predicted Mr Sugrue. A number of reinsurers could struggle to meet their cost of capital, he said. Reinsurers will not be able to rely on investment results to compensate for lower prices. Investment returns are expected to decline in 2014 before stabilising in 2015 and then bouncing back in 2016, albeit to a low 2%, according to S&P. The ratings agent predicts that average price reductions of around 5% in 2014 and 2015 could wipe out US$8.3bn of surplus, bringing the level of excess capital for the 23 reinsurers it rates down from US$50.9bn to US$42.5bn. It also noted that the sector’s combined ratio is deteriorating and is expected to break through the 100% level in 2015. Some reinsurers have already reported worsening results in the first half of 2014, it added. “We estimate that at least half of the 23 reinsurers that we rate are exposed to competitive pressures,” said Mr Sugrue. “Those with the scope and underwriting expertise are in a better position to cope with the cycle. For smaller and concentrated reinsurers, it’s not the end of the road but they will need to defend their competitive position and bottom line, and some will struggle to survive,” he said. Market conditions are likely to challenge some smaller reinsurers, agreed Mr Street. “For some there will be the issue of whether they can compete on programmes in a meaningful way. This is less of an issue in property cat, but in other lines scale and relationships matter,” he said. According to Mr Street, the growth in alternative capital may bring about a structural change in the reinsurance industry if it limits the ability of reinsurers to make good profits in low loss years. “If alternative capital does have a lower cost of capital advantage, and is permanent, then will it permanently reduce the profit margin of reinsurers?” asked Mr Street. If so, smaller reinsurers will have to adapt, which could include mergers and acquisitions, diversification or withdrawal from the market, he concluded.

Reinsurers under pressure ahead of renewals season

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