Capital Oversupply Could Pressure Reinsurers to Lower Rates

By Oliver Suess | September 4, 2013

Munich Re and Swiss Re Ltd. are among reinsurers likely to face further pressure to lower the rates they charge clients as the capital available for backing policies remains near a record high, brokers said.

“With the influx of new capital and the absence of major losses, the writing on the wall is that there will be continued rates pressure,” said John Cavanagh, chief executive officer of reinsurance broker Willis Re, in an interview.

The capital accumulated by the reinsurance industry stood at $510 billion at the end of June, just below a record $515 billion three months earlier, according to reinsurance broker Aon Benfield, a unit of Aon Plc. The surplus of funds mean primary insurers such as Allianz SE and Axa SA can demand lower prices on reinsurance policies, contracts that help limit their losses when disasters strike.

Reinsurance rates declined in seven of the last 10 years, according to the Guy Carpenter World Property Catastrophe Rate on Line Index, which tracks prices on a worldwide basis. Capital has ballooned by 50 percent since 2008, partly owing to new entrants, such as hedge funds, and the increased sales of catastrophe bonds, which allow reinsurers to suspend principal payments when losses from specific events surpass an agreed-upon threshold.

Monte Carlo

“The reinsurance market will continue to be competitive in most areas as we’ve seen the continuance of newer capital sources adding to the opportunities being available,” Nick Frankland, European head of Guy Carpenter, a unit of insurance broker Marsh & McLennan Cos., said in an interview. “Another year of relatively benign loss activity will allow for some degree of latitude to reduce rates modestly.”

Reinsurers will meet with brokers and primary insurers in Monte Carlo starting Sept. 7 to begin negotiating terms for next year’s property and casualty policies. Discussions will continue at an October meeting in Baden-Baden, Germany.

Reinsurers such as Munich Re, Swiss Re and Hannover Re typically renew about two-thirds of their annual property and casualty contracts in January, and the remainder in April and July. The April renewals focus on the Asia-Pacific region, while the July renewals are more focused on the U.S. ahead of the hurricane season in the Atlantic and Pacific.

Reinsurers face pressure on their earnings not only from declining prices but also from low interest rates that crimp investment returns.

Hurricane Season

Munich Re, the world’s largest reinsurer, said second- quarter profit fell 35 percent as claims from natural disasters rose. The Munich-based reinsurer saw its prices decline 0.9 percent in the July renewals, when it renegotiated about 13 percent of its property-casualty reinsurance business.

Zurich-based Swiss Re, the second-largest reinsurer, reported its first quarterly underwriting loss since 2011 after a surge in claims from natural catastrophes and man-made disasters. It said its prices fell about 5 percent in July, when about 20 percent of the business is renewed.

Munich Re shares gained 0.6 percent this year compared with a 9.2 percent gain for Swiss Re and a 12 percent increase for the 30-company Bloomberg Europe 500 Insurance Index.

Reinsurers’ catastrophe claims usually increase in the second half of the year with the hurricane season in the North Atlantic and typhoons in the northwest Pacific. So far this year, floods in southern and eastern Germany have been the most costly event, with insured losses of more than 3 billion euros ($4 billion), according to Munich Re.

Critical Mass

That compares with insured losses of $62 billion from Hurricane Katrina in 2005 and $40 billion from the Japanese earthquake and tsunami in 2011, the two costliest disasters for the insurance industry.

The absence of record claims and years of low interest rates have lured investors from hedge funds to pension funds to take a share of the reinsurance market. Third Point Reinsurance Ltd., which counts billionaire hedge-fund manager Daniel Loeb as a founding shareholder, raised $276 million in an initial public offering last month.

“Alternative capital is at the point now where it has reached a critical mass,” Willis Re’s Cavanagh said. “Pension funds, who invest in a lot of the new capacity, typically do a great deal of due diligence before they invest and they are here to stay.”

At the same time, annual catastrophe bond issuance reached $6.7 billion by the end of June, bringing catastrophe bonds currently in the market to a record $17.5 billion, according to a report by Aon Benfield.

‘Paradigm Shift’

“We estimate that secondary capital sources supporting the likes of insurance-linked securities and industry loss warranties make up a little less than 20 percent of the catastrophe limits purchased,” Guy Carpenter’s Frankland said. “This may represent a paradigm shift, and we can see that percentage build to anywhere above 50 percent over time.”

Industry loss warranties are a form of reinsurance where the provider of the coverage has to pay a certain amount of money when insured losses from a specified event, such as a hurricane hitting Florida, exceed a certain limit. In return, investors get a premium from the company covered by the contract.

Fitch Ratings said on Aug. 29 that continued low interest rates will make it more challenging for reinsurers to maintain the profitability forecast for 2013 next year.

Some reinsurers are considering alternatives for their capital. Munich Re said last month it will consider a share buyback, and will comment further when it reports third-quarter earnings in November. The reinsurer scrapped its latest share buyback plan in 2011 after the record earthquake and tsunami in Japan triggered the firm’s first quarterly loss since 2003.

Editors: Frank Connelly, Simone Meier

 

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