Reinsurance capital growth eases as M&A, active capital management accelerate: Willis Re

The latest Reinsurance Market Report from Willis Re shows that significant over-capacity and widespread pricing pressure has stabilized the growth in global capital from traditional and non-traditional sources dedicated to reinsurance in 2015 H1, which remains unchanged from the US$425 billion at year-end 2014.

Willis Re, the reinsurance division of Willis Group Holdings plc, reports that the record US$425 billion level reached at the end of 2014 is based on the Willis Reinsurance Index group of companies from around the globe, other major regional and local reinsurers, and a pro-rated portion of capital within major groups whose reinsurance portfolio is <10% of their total premium.

“The levelling of capital comes as reinsurers accelerate their active capital management strategies as acceptably profitable capital deployment opportunities in the market diminish,” notes a statement Thursday from Willis Re.

Despite capital levels being affected as merger and acquisition activity intensifies and transactions are completed – 10.5% of the shareholders’ equity reported within the Willis index is currently involved in major merger activity – “the challenge of oversupply remains and market pressures continue to manifest themselves in diminishing returns on equity (RoEs),” Willis Re points out.

Based on the Willis Reinsurance Index, the report indicates underlying reinsurer RoEs for the first half of 2015 are lower than during the same period of 2014.

More specifically, Willis Re notes in the statement that a 12.8% aggregate reported RoE in 2014 H1 for companies providing catastrophe loss disclosure would change – based on a subset within the Willis index group that provides catastrophe loss, as well as a more typical catastrophe year (generating circa US$60 billion of catastrophe losses) and excluding prior year reserve releases – to 7.8% in 2015 H1.

At the end of the first half of 2015, Willis Re reports that companies were showing 11.1% aggregate reported RoE, but with the more typical catastrophe year and excluding prior year reserve releases, underlying RoE would be 5.1%.

“For the subset within the Willis Reinsurance Index that breaks out the relevant disclosure, the annualized RoE, excluding natural catastrophe loss and prior year reserve releases, has decreased by 1.9 percentage points in the aggregate to 8.3% from 10.2% in H1 2014,” the report states. “Adjusting for a more typical catastrophe load simply increases the year-on-year fall in profitability to give an underlying ROE of only 5.1% compared to 7.8% in H1 2014.” [click image below to enlarge]

Market pressures continue to be exacerbated by sustained low levels of global insured catastrophe losses, which at US$16.5 billion, are now at the lowest level since H1 2006. Losses were US$35 billion at year-end 2014, Willis Re points out, and citing figures from Swiss Re, natural catastrophe losses at H1 2015 were down 35% to just US$12.9 billion compared to compared to US$19.7 billion in 2014 H1, “running at just over half the mean H1 loss from 2005-2014,” the report states.

“For those within the Willis Reinsurance Index that made the relevant disclosure, reported catastrophe loss fell by 49% to US$0.7 billion,” the report adds. This equates to “approximately a 0.8 percentage point impact on the aggregate annualized RoE (H1 2014: 1.6 percentage points).”

2015 continues to follow the recent trend of below average large catastrophe losses, the report notes. However, it adds that the contribution from man-made large losses was significant at US$3 billion. [click image below to enlarge]

“While Cat pricing remains under pressure overall, many reinsurers reported a slowing in rate declines and, indeed, that walk-away point had been reached for some programs. There is also increasing evidence of ILS funds refusing deals where margins have now fallen below their minimum profitability target,” states the report.

“In the Willis Reinsurance Index, competition appears to have intensified on certain international and specialty lines, including marine, aviation and energy business,” Willis Re notes, adding that “notably, many markets are reporting significant rate decreases in energy property business.”

“The outlook remains challenging for the remainder of 2015 as markets continue to face significant over-capacity and competitive pricing conditions,” the report states. “Overall, underwriting margins remain under substantial pressure as evidenced by the ongoing drive towards ever greater balance sheet scale and product diversification in order to remain competitive and relevant to clients.”

While underwriting margins remain under substantial pressure, there are signs that rationality in the market is beginning to emerge, John Cavanagh, global CEO of Willis Re, suggests in the statement. “There may now be evidence of capital stabilization as supply and demand begin to equalize,” Cavanagh points out.

“While a significant shift in RoE levels is being accepted by shareholders, the profitable deployment of excess capital remains a key challenge for reinsurers and is exacerbated by the low levels of loss activity,” he says. Still, “reinsurance remains attractive to investment capital in the long-term despite the diminishing underwriting and investment returns being delivered,” he adds.

Other report findings include the following:

• markets continue to manage excess capacity through active capital management strategies;

• consolidation continues as markets seek scale and product diversification;

• reported combined ratios remain broadly unchanged at 91.6% (92.1% in 2014 H1) supported by modest catastrophe losses and continued substantial reserve releases;

• pressures on profitably deploying excess capital have continued the recent trend of share buybacks and special dividends, and the continued focus on portfolio optimization was also a widely reported theme as reinsurers seek to quickly re-deploy their capital to lines of business and regions which meet profitability requirements; and

• half-year results have increased concerns around the sustainability of reserve releases (partly due to increased incidence of casualty reserve strengthening) so going forward, those who have reserved most conservatively during the soft market will reap the benefits of their approach.