Some observers believe the bottom of the reinsurance market may be in sight because brokers are having greater difficulty filling out underpriced programs and further concessions in terms are difficult to obtain, according to a report published by A.M. Best.
“While current market conditions appear to be stabilizing, competition remains intense and quality of earnings under pressure,” said the Best’s Briefing titled “Restraint in a Challenging Market Environment.”
In spite of these pressures, A. M. Best said its global reinsurance composite still illustrates reasonable results for 2016, “aided by the lack of large U.S. cat losses, ongoing capital management strategies, and continued overall favorable reserve releases.”
Sector Remains Overcapitalized
The global reinsurance sector remains overcapitalized, the report said, noting that dedicated reinsurance capacity, which includes US$75 billion of convergence capacity, will likely increase slightly in 2016 to US$420 billion compared to 2015, the report said, quoting statistics compiled by A.M. Best and Guy Carpenter.
While convergence capital, or third party capital, continues to seek a “larger piece of the pie,” A.M. Best said, “the speed of capital market capacity entering the market seems to have slowed compared to prior years and some collateralized markets have held capacity flat, unable to find suitable opportunities.”
The ratings agency emphasized that this is a healthy response to current market conditions.
As evidence of current soft market realities, the report pointed to the fact that cat bond issuance tapered off in 2015 and 2016, after strong growth in 2014.
Nevertheless, A.M. Best said growth of rated balance sheet capacity is expected to continue for 2017, barring any extraordinary catastrophe losses. Such capacity increases are the result of earnings outpacing share buybacks and dividends and are viewed as “a strategic move as reinsurance organizations appear to be positioning themselves for future opportunities,” the report said.
“In this regard, there is some speculation that attractive business opportunities may be on the horizon in the U.S. as government policy changes emerge from the new Trump administration.”
Reinsurers as Risk Gatekeepers
“Traditional reinsurers are adapting to become the gatekeepers of insurance risk and manage the risk share and alignment with alternative capital for property and non-property classes of business,” said A.M. Best, noting that this trend is expected to continue.
“There is a clear sense for the need to form larger, global, well-diversified operations with broad underwriting capabilities to assess risk and to serve as transformers of risk to the capital markets,” the report explained.
Reinsurance companies believe they can better serve insurance companies by matching risk with the most appropriate form of capital, it continued.
“[A]s all market players look to become more efficient, be it through disintermediation or going directly to sources of risk, this tug of war will result in fewer hands in the pot – ultimately making it better for the purchaser of protection but likely at the expense of some franchises that exist today.”
Strategic Moves for Long-Term Survival
Intense competition and earnings pressures are sustaining the need for further M&A, especially among smaller players “as acceptable returns become increasingly harder to achieve.”
Such market realities are fueling reinsurers’ need to innovate and search for niche businesses or strategies, which are difficult to replicate, A.M. Best said.
“Over the past few years, reinsurers have made a number of strategic moves to position their organization for long-term survival,” the report said. “M&A activity is by far the most significant of these, but we have also seen formations of joint ventures, increased research and development to find ways to close the insurance gap, use of big data in underwriting, and entry into new data-rich classes of business.”
New Business Realities
A.M. Best said the industry will have to get used to a new reality where “returns are less impressive and underwriting will have to become a larger contributor to profits and returns.”
This will lead to more cautious risk selection, more diversification of product offerings, a wider geographic reach, and conservative loss picks, the report affirmed.
Although not everyone will win in the end, the ratings agency said, those reinsurers that can take advantage of “cheaper” convergence capital from capital investors could ultimately find “significant success.”
A.M. Best said the solid players of the future will be those that:
- Remain conservative in underwriting and reserving
- Develop a relevant book of business and can shift quickly in and out of lines depending on market conditions
- Create expertise in managing third-party capital to their own advantage and
- Can participate in the new era of consolidation without being left out of the game.