As top executives of global reinsurers gathered in Monte Carlo this weekend for their annual Rendez-Vous, the outlook was cloudy despite the Mediterranean sun. Atlantic hurricane activity so far this year has been modest, while California firestorms rage, but the cost to the industry from these events will not be enough to stimulate higher rates. However, there is still plenty of potential for storm activity ahead, and not just from the weather.
Although reinsurer investment portfolios were hit hard over the past year, most reinsurers escaped the brutal bloodbath taken by their banking brethren; in part this was due to strong insurance regulation governing investment activity, but it was also due to more limited exposure to structured products and subprime loans, especially on the non-life side of the business. Moreover, rebounding markets have helped restore some of the earlier hits taken by reinsurer investment portfolios. As noted recently in Business Insurance “sixteen major reinsurers surveyed by Guy Carpenter, which collectively reported a $3.5 billion loss for 2008’s first half, posted $4.6 billion in net income for this year’s first half, in large part because of a reduction in unrealized investment losses”.
Nonetheless, Moody’s downgraded the reinsurance sector last week from stable to negative on signs that price competition is likely to increase in 2010. Fitch Ratings also holds a negative rating on the outlook for reinsurers, because of concern about reinsurers' ability to replenish capital if they suffer large catastrophe losses in the current environment. There is little pricing improvement occurring in lines other than property catastrophe, energy and financial institution D&O. Indeed, Moody’s notes that global reinsurers currently have more capacity than the demand can absorb, as the recession is slowing demand for reinsurance. Moody’s specifically notes that “with credit markets easing, solvency positions recovering, and hedge funds capacity resurfacing, many signs point to greater price competition in 2010.” The reinsurers simply have no pricing power at this time, as investment restoration to balance sheets has cut expected demand. Typically, when demand eases, the industry cuts prices to below adequate levels in order to capture market share.
As for the storm clouds, hurricane season is only half over. Also, the industry saw earnings growth in recent years from the release of redundant reserves. Consequently, there is now less of a reserve cushion available if a major event occurs. Furthermore, A.M. Best recently noted that while property reinsurance rates were up single digits globally, casualty rates were “far from adequate”. A competitive price war now would drive rates down to well below adequate levels. In addition, possible regulatory changes ranging from Solvency II to a US federal insurance czar could raise capital requirements at a time when weaker firms will be unable to raise funds or sustain adequate capital. Indeed, the US Treasury has already suggested it may propose higher capital levels for banks considered too big to fail. Those same measures might also be applied to global reinsurers.
For the stronger reinsurers with solid risk management capability and adequate capital, there are fewer opportunities to deploy capital when demand is weak. Perhaps that is why Munich Re has indicated it is considering restoring its share buyback program if conditions continue to improve in the second half of this year. The stronger firms might also consider merger or acquisition as a means to grow market share when prices are low. Already we have seen the merger of Partner Re/Paris Re (PRE) and the acquisition of IPC Re (IPC) by Validus Re (VR) after a contested battle. However, if there is a double dip recession and investment markets again recede, even the stronger firms may be pressed to raise additional capital rather than spend it on buybacks or acquisitions.
Other items for consideration by reinsurers include the Neal bill, and a return to risk taking on Wall Street. As Guy Carpenter recently noted “Rep. Richard Neal (D - MA) introduced H.R. 3424, which would limit the deduction taken by a U.S. insurance company for non-taxed reinsurance premiums paid to foreign affiliates. The purpose of the bill is to address a concern that reinsurance is being used to shift profits from the United States to low-tax or no-tax jurisdictions, creating a competitive advantage for U.S. subsidiaries of foreign corporations”. If the Neal bill succeeds, reinsurers could face higher taxes.
As for the return to risk taking on Wall Street, it is evident by the performance of zombie financial stocks that have outpaced those of more solid firms. Cat bonds are back in vogue. The bankers are now are pursuing a plan to securitize life settlements – to buy life settlements, package them into bonds, and sell the bonds to investors. So we now have deja-vous risk-taking amid the rendez-vous.
Disclosure: No positions held