A.M. Best: Reinsurers Need Underwriting Discipline in Competitive Market

January 14, 2015

Increasing competition and lower underwriting margins in the reinsurance market highlights the importance of disciplined underwriting, according to an A.M. Best briefing entitled “Global Reinsurers: Who Will Gain Despite All the Pain?”

“The market is expected to remain challenging in 2015, with rates continuing to decline for some lines of business, terms and conditions becoming even broader, and ceding commissions increasing further,” according to the report.

Managing the Cycle

“In response to these pressures, companies that are managing the cycle continue to reduce their retained exposure to classes of business that do not meet acceptable return hurdles, and they are expanding in classes that offer better opportunities,” the report continued. “In 2014 this led to significant reductions in reinsurance books of business, particularly for property catastrophe. For the most part, 2015 is expected to produce an even more careful approach to risk selection.”

The report said that this approach to risk selection appears to be working for global companies, which are expected to remain cautious on the business they write, while capacity remains high in a competitive market.

Companies with both insurance and reinsurance books of business are weighted more toward primary business where pricing is relatively more attractive with easier access to business, the report went on to say. “That said, some primary lines have started to show some negative pricing or a slowdown in price increases over the past few quarters.”

Conversely, the report said, companies that write predominantly reinsurance and focus on underwriting are in danger of reducing their books of businesses to levels that may make them less relevant in the market, which could lead to more merger and acquisition activity.

“Companies with well-diversified businesses and a global reach likely will only get larger as smaller players put themselves up for sale or seek strategic partnerships to survive,” the report said, noting that successful reinsurers require greater global scale and diversified product lines and distribution.

During 2014, reinsurance companies saw property cat price declines of 20 percent in some cases for all renewal seasons, with even more pronounced pressures in the United States, the report said.

“The dramatic price declines in 2014 continue to be attributed to the lack of market-changing losses, as well as increased retentions by ceding companies and the persistent inflow of capital from the capital markets, largely in the form of insurance-linked securities (ILS),” said A.M. Best.

“Third-party capital is expected to continue entering the market in upcoming years as large pension funds and hedge funds seek ways to diversify their portfolios while chasing higher returns,” the report said.

Convergence Capital

The report said that convergence capital — which includes industry loss warranties, collateralized reinsurance and cat bonds — continues to pour into the industry. A.M. Best cited Guy Carpenter estimates that convergence capital in 2014 amounted to USD$60 billion, up USD$12 billion from 2013. During 2013, traditional capital came to USD$320 billion.

In 2014, 43 cat bonds were issued, totaling USD$8.8 billion, a new record year for cat bond issues and a 15 percent increase over those completed during 2013.

The report noted that 44 percent of the bonds increased in size before the deals closed, which implies a strong appetite for the issued risks.

Challenges Continue in 2015

“With new capital and reduced reinsurance purchasing by some large cedents, market conditions are expected to remain challenging for the reinsurance business in 2015 and lead to further pressure on pricing, particularly in property and cat lines,” the report said.

“As premiums continue to decline, investment returns remain low, reserve releases taper, and commissions increase, it is expected to be increasingly challenging to deliver double-digit ROEs,” the report said, noting that margin compression also will likely persist as third-party capital seeks a larger piece of the pie.

“As a result, A.M. Best is forecasting underwriting performance for the U.S. and Bermuda reinsurance sector to produce an average combined ratio of 94.8 and an average ROE of 8.2 percent for 2015, representing a stubbornly difficult market environment and a normal level of catastrophe activity.”

Source: A.M. Best

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