Reinsurance Losses May Be Sufficient To Install Pricing Floor: Macquarie

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by: Steve Evans

The recent higher levels of catastrophe loss suffered by the insurance and reinsurance industry in the second quarter, may be sufficient to help install a floor on reinsurance pricing at the January 2017 renewal season, analysts at Macquarie Research have suggested.

Reports have showed that catastrophe insurance and reinsurance losses in the first half of 2016 have risen significantly compared to 2015, with Aon saying the insurance and reinsurance industry would be on the hook for $30 billion of a total $98 billion economic impact, while Munich Re said that an expected $27 billion of insured H1 catastrophe losses were above the inflation-adjusted average for the last 30 years.

So it's clear that a heavier toll is falling on insurers, and that reinsurance and insurance-linked securities (ILS) capital is providing a significant amount of support to the global insurance industry. In fact, for the ILS market, many funds will find the first half of this year brings them the highest level of losses since 2011.

As a result, analysts at Macquarie Research said that they "expect 2Q results to be relatively poor, due to the increase in catastrophe losses," although, despite the size of the losses "we do not expect these losses to fundamentally change the outlook for the industry."

But one potentially positive effect of the higher level of losses is an expectation that they will help to enforce a pricing floor, particularly in the most competitive areas of the reinsurance market where rates have already been stabilizing over the last couple of renewals.

The Macquarie analysts explain; "We expect higher losses in 2Q 2016 to help rates find a floor at the next renewals at 1 January 2017, supporting our thesis that flattening rates will limit future earnings decline."

As a result of a flattening of rates in reinsurance, Macquarie's analysts believe that reinsurers will be able to maintain yields of above 5% for shareholders, as well as share buybacks, which suggests that reinsurance industry capitalization is not set to diminish, and in fact may grow further.

"Stable rates will be a welcome change for reinsurers," the analysts note, forecasting that declines will continue to decelerate and reinsurance rates may move to a broadly stable state by the end of the year, with declines at the key January 2017 renewal expected to be minimal.

"Considering that prices already appear to be stabilizing, we believe that the recent increase in catastrophe losses will prompt more underwriting discipline and thus forecast flat pricing at future renewals," the analysts continue in their report.

However, it's worth noting that losses appear aligned with reinsurers exposure and have not been large enough to show up any poor discipline, or expansion of terms and conditions. Hence reinsurers may continue to write expansive renewal policies, even if rates do stabilize, so the question of discipline may still apply at the low rates expected at January 1, 2017.

Another factor that could help to promote reinsurance rate stabilization at January 1st is a perception that casualty reserves are weakened, which the analysts note as a key risk.

Macquarie explains; "Considering forecasts for potential reserve strengthening, we believe this will prompt insurers and reinsurers to be more prudent with pricing and thus prices will be flat at future renewals."

The analysts at Macquarie clearly believe that the recent stabilization will continue, and the pricing floor which first became evident earlier this year, and was again evident at June 1 renewals, could be installed by the end of 2016. It seems safe to assume that this will be the case, as so many regions and perils are already being underwritten at levels close to expected loss, meaning there is little room for further declines.

However, the analysts also seem to agree that the pressure will not let up anytime soon with much larger losses required to push reinsurers to re-evaluate their pricing entirely.

There will of course be ongoing pressure and competition from ILS markets to deal with as well, with further inflows of new capital expected in time for the key January renewal season.

The question then becomes whether a pricing floor is a temporary or more permanent indicator of the bottom of the market, or the future of reinsurance pricing and the cost of reinsurance capital?

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