Storm Clouds on the Reinsurance Horizon despite Record Capital

By | September 9, 2014

As the reinsurance industry prepares for its annual get together in Monte Carlo next week, a number of analytical reports have appeared, which show that, despite some significantly good numbers for the first six months of 2014, there are storm clouds on the horizon that will ultimately affect the entire industry. Mike Van Slooten, the Head of Aon Benfield’s International Market Analysis team, explains why in a telephone interview.

“The first half of the year has been good for reinsurers,” he said; adding, however, that the “underlying fundamentals for global reinsurers aren’t so good.” Despite the numbers for the industry detailed in Aon Benfield’s recent report, there are a number of weak points that indicate trouble ahead.

Van Slooten explained that the robust results for the first half of 2014 are based on prior business activity rather than future market conditions. They reflect the absence of any significant losses during the period, as well as the investment support, mainly in bond prices, that reinsurers were able to employ until recently.

“That will end,” Van Slooten said, as “there will be major cat losses and bond values are going down.” In addition the oversupply of capital in the reinsurance market continues to depress reinsurance rates. He explained that while most of the larger reinsurers, from whom the survey results were derived, do write divergent panoply of risks, but for a number of reinsurers the major source of earnings remains the property catastrophe market.

“In 6 to 9 months the above factors will begin to affect the market, putting earnings under pressure,” Van Slooten said. “In global terms property cat is around 20 percent of the market, but cat business is a significant proportion of profits – in many cases 50 to 60 percent.”

Van Slooten also sees no significant change in the continued influx of alternative capital into the reinsurance market. As a result there will continue to be “too much capital and less opportunity to deploy it.” He also indicated that even if there were some significant reinsurance losses, which might cause some alternative capital players to withdraw from the market, there are many sophisticated investors, “who’ve done their due diligence, and know what they’re doing.” They will continue to provide capital.

Most of the larger reinsurers are taking measures to avoid, or at least lessen the impact of, the coming downturn. “They’re moving into casualty, especially in the U.S., and the bigger players are ‘on the ground’ in emerging markets. They’re focusing on other business lines and less on property cat,” Van Slooten said; notably “accident and health, mortgage and credit insurance.” The larger reinsurers can enter these markets fairly easily as most of them also write primary coverage as well as reinsurance.

Van Slooten’s somewhat pessimistic view is backed up by the recent actions of the main rating agencies. Standard & Poor’s issued a warning in August . A.M. Best, Fitch and Moody’s have all expressed concerns that global reinsurers’ profits will decline, to the extent that their ratings could be affected. “They all have negative outlooks on the [reinsurance industry’s ratings,” he said.

Eventually these factors will have an effect on the reinsurance market, especially on smaller companies and those specializing in property catastrophe coverage. “They will be under pressure within the next six months,” Van Slooten said. “It’s the final catalyst for consolidation.” There’s no telling when M&A activity in the reinsurance industry will begin, nor to what extent the consolidations may have, but it is an eventuality for which the industry should prepare.

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