Priced to Sell

In the reinsurance marketplace today, there is no denying that competition is stiff. Whether that competition is coming from traditional or new players, linked to catastrophic events or the continuing low-interest environment, reinsurers are recognizing the need to consider adjustments while holding firm to principles and approaches that have worked in the past.

Existing market conditions continue to apply downward pressure on pricing. Some suggest that the reinsurance market is, in fact, at or near the bottom of the pricing cycle. Absent (or perhaps even with) the next big Cat or interest rate hike, it appears as though this downward pressure will remain until changed by demand.

That said, competitors are joining the Canadian reinsurance party, even with a declining premium pool. This makes the market an attractive one for buyers of reinsurance, but also emphasizes the importance of maintaining, if not strengthening, existing relationships by creatively engaging with clients.

Existing conditions may also demand that reinsurers consider new ways of deploying their capacity and diversifying their portfolios.

PRICE ADJUSTER

On a global scale, reinsurance pricing is certainly under pressure. “The tentacles of the softening market are spreading far and wide, with no immediate signs of relief,” John Cavanagh, chief executive officer of Willis Re, said in a statement July 1 as the reinsurance broker issued its 1st View Renewals Report.

“We’ve seen muted demand throughout 2014 and market dynamics are unlikely to change for some time to come,” Cavanagh suggested.

“It is clear that the pace of the pricing decline observed in 2013 has not relented,” Lara Mowery, global head of property specialty at Guy Carpenter, noted following the release of the company’s June 2014 renewal briefing.

Here at home, “the domestic reinsurance marketplace continues to see strong pricing competition which has provided mid-year renewal pricing terms in some circumstances at or below program ‘burn’ rates,” reports Eric Steen, executive vice president, reinsurance for JLT Towers Re.

“While we are almost certainly at or near the bottom of the pricing cycle,” suggests Matt Wolfe, senior vice president and managing director of Beach and Associates, “reinsurers will still walk away from business that fundamentally doesn’t make sense,” Wolfe says.

“Abundant Cat capacity, in any format (traditional or non-traditional), will create more competition among reinsurers, especially if it coincides with low loss experience locally,” explains Joseph El-Sayegh, senior vice president of property and casualty, Canada for SCOR Canada Reinsurance Company.

“Cat capacity is abundant in the global market due to well-capitalized companies that benefited from a benign Cat year in 2013, while the Canadian market is buying less due to the measures that each company have put in place to control their Cat accumulations. This drove the prices to drop or, at best, remain unchanged,” El-Sayegh reports.

“The only exception was the treaties affected by Cat losses in 2013, mainly due to Alberta and Toronto floods. These events provided some price ‘correction’ rather than price ‘improvement,'” he adds.

In an article in Canadian Underwriter this March, Rohan Dixon, chief broking officer for Aon Risk Solutions, wrote that while losses from 2013 events – such as the flooding in Alberta and around Toronto – were severe, it is important for Canadians to know that primary insurers and reinsurers have been able to absorb these losses, leaving available capacity relatively unchanged and the Canadian insurance marketplace comparatively unaltered. The insurance market would need to see a prolonged trend of large non-catastrophe losses and a decline in the availability of surplus capital to shift to a hard market environment, Dixon noted.

COMPETITIVE ENVIRONMENT

“New entrants to the Canadian reinsurance market are attempting to gain their share of the business, and this added supply of capacity can only be viewed as further pressure on those longer-standing markets to reduce program-quoted renewal terms year over year,” says Steen.

Wolfe points out that “the reinsurance market is competitive, and is expected to remain so due to a decline in ceded reinsurance premium volumes in the last decade. The ceded reinsurance premium volume reported to the Reinsurance Research Council (RRC) was $2.7 billion in 2004; in 2013 it was less than $2.2 billion.”

In spite of a declining premium pool, he says that new reinsurers have continued to enter the Canadian reinsurance market in recent years. “The increasing supply and diminishing demand means that this market will remain an attractive one for buyers of reinsurance,” he adds.

“Continued benign loss activity throughout the first half of 2014 has compounded the softening market,” Willis Re noted after the release of its 1st View Renewals Report. “Inflows from capital markets have continued to add to the excess supply of capital, although much of the competition has also been driven by the traditional reinsurance markets,” Willis Re observed.

This looks to be good news for buyers, who are “reaping the savings offered by the market and are not generally seeking to recycle the saved premium spend back in to increased reinsurance purchase,” the company adds.

CAT IMPACT

“If the supply of capacities remain abundant, the expectations are to see some pressure on rates, in the absence of severe Cat events,” El-Sayegh says.

But the payback on the 2013 Cat losses “will not happen over one year, and the expectations are that reinsurers will continue accounting for these losses in their pricing,” he explains.

Says Wolfe, “If 2014 is a relatively quiet catastrophe year, both within Canada and globally, there is no reason to expect the reinsurance marketplace to change materially.”

Globally, Steen notes, reinsurers stocks have performed very well with strong return on equity (ROE) and earnings over the past year or so.

In April, Aon Benfield released the 2013 financial results of its aggregate of 31 reinsurers. The information notes a 3.4-point drop in the catastrophe loss ratio and a 46% increase in underwriting profit. The combined ratio for the (Aon Benfield Aggregate) was 89.6% in 2013, down from 92.4% in 2012, while the catastrophe loss ratio was 4.7% in 2013, down from 8.1% in 2012.

How long is the strong ROE and earnings for reinsurers expected to last?

“The local and global reinsurance landscape will continue to be competitive until an event (nat-Cat or otherwise) is presented with a $50 billion to $75 billion or greater loss amount, Steen suggests. “Even then, recent past occurrences (Hurricane Sandy) had a very modest financial impact with available capacity continuing to be generous,” he notes.

“The current market position is increasingly challenging for reinsurers,” Willis Re’s John Cavanagh suggested in early July. “Below-average loss ratios in the first half of 2014 and reasonably adequate reserving positions mean that, barring any major underwriting or investment losses in the coming months, we will see another year of reasonable returns. This places further pressure on rating levels for 2015,” he continues.

Aon Benfield’s 2013 Insurance Risk Study highlights that for the past 10 accident years, the Canadian property and casualty market has achieved a 98% combined ratio with insurers between the 25th and 75th percentile reporting a combined ratio of 92% to 103%, Dixon noted in the recent Canadian Underwriter article. With investment returns strained by low interest rates, insurers must look to improve their financial results by increasing their underwriting profit, either by writing more policyholder risks, or by tightening underwriting guidelines (thereby reducing claims losses) or both, he pointed out.

IMPACT OF ILS

Willis Re suggests in the 1st View Renewals Report that as major ratings agencies have moved their outlook on the global reinsurance sector to negative in recent months, the focus has been on “the role of the insurance-linked securities (ILS) markets in driving down pricing in the high-margin U.S. catastrophe market, which has produced the lion’s share of reinsurers’ overall returns in recent years.” As well, Willis Re notes, “the emergence of ILS capacity in other non-catastrophe lines of business has been highlighted by ratings agencies as an area of concern.”

Guy Carpenter’s 2014 mid-year analysis, which was released in early July, highlights the continued growth of the catastrophe bond market. It points out that new bond issuance had reached US$5.7 billion by mid-year, with the total risk capital outstanding now sitting at all-time high of US$20.8 billion (excluding private placements).

“In the absence of severe catastrophic events, Aon Benfield Securities forecasts that 2014 will be another positive year for the Aon Benfield ILS Indices, as the market broadens the spectrum of available risks and expands coverage to also encompass the lower layers of sponsors’ reinsurance programs,” states Insurance-Linked Securities First Quarter 2014 Update, released this April.

Guy Carpenter points out in its June 2014 renewal briefing that investor demand for ILS continues to be robust, with capacity emanating from alternative markets now accounting for roughly US$50 billion or 15% of global property catastrophe reinsurance limit.

“As catastrophe bond pricing continues to fall, reinsurers are continuing to find ways to compete. New product offerings are abundant, as flexibility and tailored coverage are becoming trademarks of this rapidly evolving market,” Guy Carpenter’s Lara Mowery noted in a statement at the time.

In the first half of 2014, Aon Benfield Securities notes in a quarterly update report in early July, the ILS market saw issuance of US$5.9 billion, surpassing the first half of 2013, which saw US$4.0 billion in issuance.

“After a strong 2013, the ILS market has managed to increase its momentum through the first and second quarters of this year, with new records being set for issuance volumes and more catastrophe bonds on-risk than at any other time in the market’s history,” Paul Schultz, chief executive officer of Aon Benfield Securities, says in a statement.

“We believe that there are still further opportunities for expansion, especially if the sector continues to innovate in terms of its product offerings,” Schultz adds.

“Reinsurers will need to continue to look for new ways of deploying their capacity as Cat bonds and related ILS contracts are slowly emerging as an alternative, in some isolated situations,” Steen suggests.

El-Sayegh comments that “the emerging market conditions (e.g. alternative capital) could be interesting to a limited number of insurers in Canada and the traditional reinsurers are adapting their product offering to this reality, hence protecting their market share.”

MOVE TO DIVERSIFY

Traditional reinsurers must remain relevant and be mindful of areas into which they are looking to diversify in the face of increased competition from the influx of capital markets capacity, Willis Re president Paddy Jago cautioned in a video blog on WillisWire in March.

Those traditional property catastrophe reinsurers that are responding to increased competition from the influx of capital markets capacity by diversifying into other lines of business should proceed with caution, Jago recommended.

“What concerns me is that you’ll have markets going into areas where they have no idea what they’re doing,” he said. “But if they don’t understand what they’re doing, they could end up exacerbating their problems, and instead of growing their top line – which is the reason they’re entering new markets in the first place – they could end up exploding their bottom line,” he added.

“For large reinsurers, diversifying the portfolio is a must by line of business and territory,” El-Sayegh advises.

“However, the key element is to have the right profitability balance between all of these lines (nat-Cat business and multi-lines),” he explains. “We are seeing bundling of casualty lines where companies are buying treaties that combine general liability and professional liability lines of business. Similarly, we are seeing more international companies buying global programs and only purchasing underlying covers for Canada.”

This past May, Swiss Re reported that a “benign natural catastrophe experience” helped the company post net income of US$1.2 billion for 2014 Q1. “Swiss Re successfully diversified its portfolio through tailored large transactions, writing less natural catastrophe business and expanding into casualty, which has seen profitable growth across all regions. This is in line with Swiss Re’s strategy to allocate capital to lines of business with the most attractive returns,” the company adds.

Overall, “with reinsurance spend and inwards book concerns, interest in bundling reinsurance into multi-line placements, for example, and alternative products such as catastrophe bonds, has remained high in 2014,” Guy Carpenter notes in its June 2014 renewal briefing.

Mowery said at the time that a main challenge facing reinsurance buyers is the expanding variety of structure options from a growing number of providers. “The dynamics of this renewal season demonstrate the benefits of consistent communication with markets and a thorough understanding of the risk being presented, particularly in a rapidly evolving marketplace,” she pointed out.

“Although we have not seen new capital entrants in Canada yet, the inroads that have been made in other markets – especially in the U.S. Cat markets – are forcing some reinsurers to seek to diversify their portfolio and this is increasing competition in Canada amongst traditional reinsurers, including Lloyd’s,” El-Sayegh reports.

“The presence of ‘cheap’ alternative capital in reinsurance – whether in the form of ILS reinsurers, sidecars or other forms – will remain as long as the general interest rate environment remains low. This is as much a driving factor as the benign Cat year for 2013. So the market will change only once other forms of investment are becoming more appealing than reinsurance,” he explains.

Guy Carpenter’s 2014 global renewal report, released this past January, notes that “while a wide range of options were considered based on specific priorities, clients most commonly sought an extension of hours clauses, improved reinstatement provisions and expanded coverage for terror exposures.”

Multi-year coverage “was also more widely available, with enhanced features such as price adjustment caps,” it adds.

Wolfe suggests a competitive market means reinsurers are more prepared to consider alternative programs, including among others, stop loss covers, aggregate covers and structured covers.

“The competitive state of the market should allow clients and their intermediaries to structure customized programs that more effectively address their clients’ individual needs,” he says.

“The traditional approach of risk excess of loss (or, less frequently, quota share programs) combined with a vertical catastrophe tower is often not the most efficient solution for the client from either a capital preservation or earnings protection perspective,” Wolfe suggests.

In the competitive environment, Guy Carpenter states in its 2014 global renewal report, most traditional reinsurers responded by adopting a less standardized, more tailored reinsurance product.

“In doing so, many reinsurers offered more tailored coverage utilizing options, such as aggregate and quota share cover, multi-year arrangements and early signing opportunities at reduced pricing,” the report adds.

“Buyers continue to place a high value on historical relationships with traditional reinsurers,” Nick Frankland, chief executive officer of EMEA (Europe, the Middle East and Africa) at Guy Carpenter, said in a statement announcing availability of th e report.

“With pricing significantly lower in most lines, reinsurers are offering increased flexibility on reinstatement provisions and other terms and conditions, which is helping clients to obtain more from core partners,” Frankland added.

BROKER ADVANTAGE

“The brokers represent their clients, in this case the insurance companies,” says El-Sayegh. The better “they represent their clients and allow the reinsurers to build the knowledge of their portfolio, their underwriting and their needs, the better the reinsurers should evaluate and underwrite that portfolio. This comes to expertise and relationships,” he adds.

“Designing and placing reinsurance programs that help them accomplish these goals is only the beginning of a good broker’s contribution to his client,” Wolfe says. “The identification of market opportunities and assistance in executing on them is what separates a mere placing broker from a true partner and trusted advisor,” he emphasizes.

Reinsurers and fund managers are being forced to examine their strategies carefully, notes Willis Re’s 1st View Renewals Report, adding that “buyers’ tiering of their reinsurance capacity suppliers, in traditional, collateralized and ILS markets, is adding to competitive pressure.”

It is anticipated that these conditions “could lead to more mergers and acquisitions, capital restructuring and formations of sidecars with ILS investors,” Willis Re adds.

Although Wolfe notes reinsurers are protecting their renewal portfolios and new business is being priced aggressively, “pricing reinsurance today generally involves a variety of technical tools (including actuarial analysis and Cat modelling) and collaborative review practices where underwriting decisions involve some type of committee approach. This discipline allowed reinsurers to post a combined ratio just below a 100% for 2013 in spite of insured catastrophes exceeding $3 billion.”

In Insurance Market Outlook 2014, released in May, Munich Re reported the company is “expecting moderate growth averaging 2% (in real terms) up until 2020.”

Worldwide, reinsurance “should also benefit from the growth momentum of the global economy and the primary insurance sector,” the report notes. In the p&c segment, however, “cyclical pressure on rates and increasing retentions will have a dampening effect on global premium growth in the short term.”

DOWN THE ROAD

El-Sayegh says it is too early to tell how nat-Cats will affect pricing and capacity. “We are only six months into the year, with hurricane season at its beginning in the U.S., and with weather-related catastrophes historically taking place in the summer in Canada. To impact pricing and capacity for the Canadian market, it needs a change in the balance of the supply and demand equation,” he says.

“There will be a number of reinsurers that will successfully navigate through these challenging times by expressing a willingness to creatively engage with clients while also having the technical acumen and underwriting discipline to secure an adequate financial return for their stakeholders,” Wolfe says.

“They will need to generate more than 2013’s low single-digit ROEs to keep capital committed to the Canadian reinsurance marketplace over the long term,” he contends.