Reinsurance pricing floor remains elusive: Willis Re

Reinsurance rates at Jan. 1, 2016 renewals have continued to decline across the majority of markets, with Willis Re reporting Monday that earlier forecasts for a “softening in the softening” in pricing have proved illusory.

“Despite the signs of pricing stabilization in peak property catastrophe zones at the June/July 2015 renewals,” notes Willis Re’s latest 1st View Renewals Report, the market has not seen the softening in reinsurance pricing that was anticipated at that time.

“The January renewals have, unfortunately, confounded the hopes of commentators that the market was reaching a pricing floor,” John Cavanagh, global CEO of Willis Re, the reinsurance division of Willis Group Holdings, explains in a company statement.

Although most reinsurers closing their 2015 accounts will likely report reasonable headline results, Cavanagh comments that “looks flatter to deceive. As the Willis Reinsurance Index for the first half of 2015 demonstrated, underlying RoEs (return on equity) of reinsurers are at an extremely low 5.1% after adjusting for reserve releases and abnormally low catastrophe losses.”

Willis Re points reports there have been few examples of any slowdown in pricing deterioration across most markets, pointing out the following:

• large losses and reductions in original rates in the global specialty markets, especially within the aviation and energy sectors, have yet to dissuade the inflow of additional capacity, meaning that reinsurers have faced difficult renewal dynamics;
• despite an increase in adverse results across a number of non-motor classes, casualty markets have not offered reinsurers any relief from further rate reductions; and
• risk-adjusted rate reductions continue for property catastrophe pricing, although there has been a notable slowdown in rate reductions for high-layer U.S. property catastrophe covers where the insurance-linked securities markets have taken a more disciplined approach.

“ILS markets have largely taken a more disciplined approach to pricing, given their business models do not allow the same degree of flexibility through diversification as traditional reinsurers,” the report states. “This trend has underpinned the difference in rate reductions between U.S. property catastrophe excess of loss contracts – particularly on the higher layers – compared to those outside the U.S. where the ILS markets have less penetration.”

With regard to conditions in aviation or energy markets, the report notes that this is leading to a prolongation of softening rates. “As reinsurers continue to diversify their portfolios, MGAs, particularly in U.S. specialty classes, are growing strongly. These offer opportunities for reinsurers to access business that will support the build-out of their specialty incomes, although this comes at the expense of some traditional specialty insurers,” it states.

Looking specifically at Canada, the report offers the following observations about the property market:

• benign property catastrophe and property per risk reinsurance environments in 2015;
• it is anticipated Canadian property reinsurers will generate sub-80% combined ratios;
• the launch of the first residential “water insurance” policies, offering an overland flood endorsement to traditional sewer back-up protection, means this optional flood coverage has been extended to in-force reinsurance treaties;
• alternative capital continues to offer buyers access to competitive reinsurance capacity; and
• top-layer property catastrophe ROLs range between 1.7% and 2.0%.

With regard to the casualty market in Canada, the report notes the following:

• driven by strong insurance and reinsurance underwriting results, the Canadian casualty market has continued to soften through 2015;
• automobile casualty and general liability reinsurance retentions continue to trend higher on the back of rising minimum capital (MCT) ratios being realized by Canadian cedants;
• cyber risk and other emerging coverages are creating new opportunities;
• Uber, telematics and autonomous vehicles are requiring insurers to rethink traditional automobile liability underwriting assumptions and exposures;
• specialty casualty classes are leveraging the competitive landscape and purchasing more reinsurance coverage; and
• once favorable reserve and IBNR adjustments continue to diminish year-over-year.

Overall, 2015’s “full-year analysis is likely to show further reductions as under-reserving issues start to appear at both a primary company and reinsurer level,” says Cavanagh (pictured left). “Under reserving issues are starting to appear at both a primary company and reinsurer levels, and current year combined ratios in many classes are approaching 100% when adjusted for normal loss patterns,” the report adds.

That said, Cavanagh says two positive developments stand out:

• Lloyd’s recently announced plans to launch a trading index to help stimulate the development of a secondary trading market and “attract the interest of the wider capital markets”; and
• Mark Carney, Governor of the Bank of England and Chairman of the Financial Stability Board, announced an industry-led task force to develop company disclosures for investors to assess physical, liability and transitional risks from climate change and related policies.

“Quantification and disclosure of insurance risk has helped drive reinsurance demand for the last 25 years,” Cavanagh reports. “These new initiatives are primed to do the same for the global business community: drive demand.”

While the announcements are positive, some negatives persist. The report cites signs that some insurers are using rate reductions to buy more reinsurance, while some larger firms are increasing their reinsurance retentions.

While improved risk management is largely driving this trend, the report warns of the possibility that increased retentions are also a result of some potentially misplaced optimism around underwriting results as primary rates continue to reduce, Willis Re reports.

“The current challenging outlook has prompted rating agencies to reinforce their negative outlook on the entire reinsurance sector,” notes the report.

In addition, the report notes the negative outlook for investment income remains, and the mergers and acquisitions trend continues unabated.

“For M&A, there is a growing perception that scarcity of attractive targets will continue to increase over time (deals beget deals) driving premium valuations, in both the public and private markets, across sectors and geographies,” the report states. “Mid-market and smaller players evaluating strategic alternatives and potential partners in the midst of consolidation with larger players actively searching for attractive targets. We are in the midst of a seller’s market,” it adds.

“The current high valuations are increasing the inherent risk in M&A transactions. This should give potential acquirers without very clear strategic targets and strong nerves even more reason to proceed carefully, but many remain confident,” Willis Re advises in the statement.