Reinsurer capital down 2% to US$565 billion in 2015 Q3 from year-end 2014, but reinsurance transactions supported by high-quality capital

Despite reinsurer capital being down 2% to US$565 billion in the third quarter of 2015 compared to year-end 2014, Aon Benfield’s outlook for Apr. 1, 2016 reinsurance renewals is positive, with insurers expected to see improvements in pricing terms and conditions similar to that achieved for clients at Jan. 1, 2016.

“The value proposition of reinsurance improved further and insurance companies continued to incorporate reinsurance capital with modestly better pricing, terms and conditions into their underwriting capital structures at January 1, 2016,” states the newly posted Jan. 2016 edition of Aon’s Reinsurance Market Outlook, which provides readers an analysis of the key variables affecting reinsurance buyers during the Jan. 1 reinsurance renewals.

Although the modest decline in reinsurer capital at 2015 Q3 compared to its peak position at year-end 2014, the outlook notes, “reinsurance transactions remain supported by high-quality capital.”

Aon further points out that “adverse currency fluctuation and unrealized investment losses impacted reinsurance capital, offset by stable operating earnings aided by continued light catastrophe activity.”

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Insured global catastrophe losses in 2015 were at their lowest levels since 2009, notes the outlook. In 2015, global insured losses were tentatively listed at US$32 billion (subject to change), down 48% from the 10-year average of US$61 billion. With the exception of winter weather and wildfire, the rest of the natural disaster perils were either at or below their recent 10-year averages (2005-2014).

Aon notes that every major region of the world sustained below average annual insured losses in 2015, although the Americas (non-U.S.) were the closest to its 10-year average. “The combination of the magnitude-8.3 earthquake in Chile, an extended drought in Canada and flooding in Chile all led to higher insured losses in the region. Severe weather events in Canada also caused notable losses,” states the outlook.

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“Many more traditional reinsurers have incorporated alternative capital into their underwriting capital structures and enhance offerings to their primary insurer customers (longer contract duration, eased reinstatement terms, hours clauses, etc.),” Aon states. Alternative capital increased further in the third quarter of 2015 to US$69 billion, “essentially doubling the property catastrophe reinsurance capacity of the market.”

In fact, total alternative capital was up 8% through 2015 Q3 and remains impactful to the overall market for risk transfer. “Barring a significant shift in supply and demand dynamics, we maintain our estimate that alternative capital will reach US$120 billion to US$150 billion by 2018,” Aon predicts.

“The most important development in insurance over the last 20 years has been radical improvements in the technologies available to deploy capital very quickly, as and where needed: the story of alternative capital,” notes the report.

Noting that the lower cost underwriting capital may be permanent, “it is having profound changes on how insurance companies structure their balance sheets and bear risk,” Aon explains. And with most of the alternative capital flowing to the industry coming from pension funds – which have a very long dated view of investing in sectors that are uncorrelated with equity, interest rate and credit risk – “this capital needs to be incorporated into the underwriting capital of insurers, whether accessed directly through a sponsored vehicle, or indirectly through reinsurance (which, in turn, leverages the new capital),” notes the report.

“Many seasoned buyers are re-evaluating their buying strategies, moving away from buying only to protect tail risk and towards recognition that new capital potentially provides cheaper risk capital at many different points along the risk spectrum,” Aon notes. “Early-adopters of cheaper underwriting capital will secure an early-mover advantage in the market to help drive premium growth,” it adds.

In 2015, “leading reinsurers invested heavily in skills and processes to allow more of our clients’ risks to be managed in the reinsurance market,” the report states, adding these “commitments will need to continue and broaden beyond the early-movers to allow us to continue to meet growing demand in six areas.”

Those areas are as follows:

• U.S. mortgage credit risk;
• life and annuity risk;
• privatization of government risk;
• regulatory and rating agency capital model adoptions and enhancements;
• tactical reinsurance transactions;
• emerging insurance risks – strong insurer capital positions and a reinsurance market focused on securing new premium has led to line of business expansion, with flood, cyber and corporate giga liability being potential expansion opportunities for the market (driven by higher levels of losses and board level risk appetite); and
• potential mergers and acquisitions activity.

Expected to continue in 2016 are the growth opportunities that began taking hold in 2015. “Mortgage, cyber and flood reinsurance all supported opportunities in primary market development while some government-related entities also effectively secured more reinsurance capacity than in years past,” Aon notes.

With regard to cyber, the company points out that the demand for related insurance coverage and products continue, with some carriers seeing their portfolios grow by more than 20% to 30% over a 12-month period.

“Demand for reinsurance has been created for a number of reasons, including aggregations to risk in certain industries, the potential of systemic exposure to large scale event risk, and the overall unknown based on a growing and evolving exposure,” the outlook notes.

For flood, “the reinsurance market is showing that there is confidence in the analytics to price these risks and to reinsure portfolios of flood risk,” states the outlook. “This is primarily based on the flood models that are becoming readily available and the confidence in the science underlying these models. There is now an opportunity for insurers to evaluate the flood risk and look to provide coverage for these properties,” it adds.

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Other trends expected to continue include the following:

• improved reinstatement terms in many programs, multi-year coverage and support by reinsurers and insurers of unique structures, insurance strategies and lines of business. “More of this trend is expected in 2016 as reinsurers maintain strong capital positions and find continued pressure from the alternative markets.”
• prevailing catastrophe bond market trends, with the continuing privatization of public risks through residual market transactions, further utilization by non-insurance corporate sponsors, an increasingly diverse and expanding covered area and exposure base, and an increase of issuance by reinsurers; and
• rating agencies and regulatory authorities becoming increasingly mindful of company catastrophe risk tolerances, thereby emphasizing the importance of management identifying and evaluating risks throughout the organization, which could impact company enterprise risk management practices and, ultimately, reinsurance purchases.

“Tailored solutions for clients are more widely accepted by reinsurers and have led to growth in a number of lines of business,” the outlook points out.

“Many have put even further focus throughout 2015 on client intimacy, enhanced risk analytics, broader product and distribution capabilities, and capital market relationships, while at the same time simplifying and streamlining their businesses wherever possible to maximize operating efficiencies,” it adds.