Canadian Underwriter

No respite for reinsurers at Jan. 1 renewals, M&A activity now reality: Willis

January 5, 2015   by Canadian Underwriter

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Insurance and reinsurance broker Willis Group Holdings plc reports that reshaping of the global reinsurance market is now reality, citing relentless rate reductions, low investment returns and the continued influx of alternative capital.

Long-rumoured mergers and acquisitions (M&A) activity “is now reality, with some companies recognizing that any further delay is only likely to see further deterioration in their valuations,” notes a Willis Group statement announcing the latest 1st View renewals report from Willis Re, released three times a year.

“With only a limited supply of attractive target companies, consolidators looking for scale and diversification are moving as company valuations become more reasonable for both parties,” the company reports.

“Tiering of reinsurers is gaining wider traction, putting real pressure on smaller reinsurers and mono-line catastrophe writers who have the additional burden of competing with the capital-efficient and highly competitive capital market-backed funds and sidecars,” the Jan. 2, 2015 statement points out.

“Their main area of interest still remains short-tail natural catastrophe, though some are moving into other classes. However, there is evidence of market-changing structures where primary carriers directly access capital markets through sidecar-type structures, entirely bypassing the traditional reinsurance market,” explains the report introduction.

In the current environment, says Willis Re chairman Peter Hearn, “many reinsurers recognize they can no longer hope for salvation through major market losses or increasing interest rates. Their only sustainable course of action is to change their business models, portfolio mixes and to strive for scale.”

Current conditions – rate reductions, low investment returns and the influx of alternative capital – “have offered no respite for reinsurers at the Jan. 1, 2015 renewal season, with a reshaping of the global reinsurance industry now starting in earnest,” notes the Willis statement.

As expected, Willis reports that downward pressure on reinsurance rates continued across almost all lines and geographies, along with improved terms and conditions, with abundant oversupply of capital continuing to outstrip demand following yet another year of benign loss activity.

“The business model of focused underwriting excellence in a limited number of lines has lost its luster. The new mantra is diversification. Whether this is by class or by geography – preferably both – reinsurers are being actively rewarded both by investors and buyers who see diversification as key to sustainability, along with size,” the report introduction states.

Despite the need for diversification, though, the report points out that not all reinsurers are accepting wider terms and conditions in addition to reduced rates.

“A number of buyers have given firm order prices above the best market terms to maintain their relationships with key partners,” Willis notes in the statement. “Some reinsurers are also actively scaling back their portfolios and going into 2015 with reduced budgets – particularly within the natural catastrophe sphere – helping to resist overly aggressive pricing and terms and conditions,” it continues.

The report further notes the anticipated influx of hedge fund-backed reinsurers also appears to have abated, although this is more closely related to rating agency hurdles than to current market conditions.

Adding to reinsurer woes as they look to 2015, “are the predictions that the global reinsurance market is only just managing to cover its cost of capital in 2014 and may fail to do so in 2015,” Willis Re CEO John Cavanagh says in the statement.

Cavanagh emphasized the need for the reinsurance sector to create depth. “Arguably, the continued lack of demand and oversupply of capital can only keep driving pricing down: unlike other financial markets, the reinsurance market lacks inherent depth, with no structured secondary trading market to help absorb the excess capacity,” he explains.

In the report – under the heading, Property – territory and comments – Willis notes of conditions in Canada:

  • no reinsurance loss activity in Canada in 2014 on risk or catastrophe;
  • reinsurers running attractive combined ratios in the 80s;
  • buyers split on taking a relationship versus opportunistic approach;
  • renewals have run late with the theory that opportunistic buyers can force reinsurers to authorize on late firm orders due to market conditions; and
  • top layer rates on line driven below perceived minimum of 2%, but still a reasonable 1.8% as reinsurers hold the line.

Also for Canada – under the heading Casualty – territory and comments – the report notes the following:

  • casualty market continues to soften, with good underlying insurance and reinsurance results;
  • Ontario auto reform seems to be working, although there are skeptics in the market with a backlog of low reserved claims in the system;
  • cedents raising retentions above $2 million for Ontario auto on a consistent basis, removing reinsurance premium from the market; and
  • specialty classes buying more reinsurance.

Overall, with regard to capital markets, the report notes the following:

  • catastrophe bond spreads have declined 15% to 20% year over year;
  • 2014 has been a record-breaking year for non-life catastrophe bond issuance with approximately US$8 billion of issuance this year, collateralized reinsurance also continues to grow, and although the rate of growth may not be as pronounced in 2015, there are no signs of growth abating;
  • secondary trading has picked up with the end of the benign hurricane season and the robust new issue activity;
  • investors have increasingly strong interest in sidecars and quota shares structures;
  • M&A activity has recently accelerated as carriers continue to look for increased scale to combat competitive market pressures; and
  • smaller under-scale carriers lacking competitive differentiation are beginning to evaluate their strategic alternatives.

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