In an interview with Artemis, Directors of S&P Global Ratings' reinsurance analytical team have discussed pricing in the global reinsurance sector as the January 1st, 2018 renewals season approaches. The prospects of insurance-linked securities (ILS) were debated, as well as other burning industry topics, such as new business lines, pressured markets, and the impact of hurricane Harvey.
The interview includes the thoughts of Johannes Bender, Director; David Masters, Director; and Maren Josefs, Associate Director, all of which form part of the S&P Global Ratings reinsurance analytical team.
With the reinsurance sector under significant pressure from a series of headwinds that show little sign of abating anytime soon, Artemis was eager to gain some insight into how S&P sees reinsurance pricing at the January 1st, 2017 renewals.
Johannes Bender, provided some thoughts on the matter;
Both the January and April 2017 renewal periods gave the sector a feeling of a déjà vu, as pricing kept falling. According to JLT Re's Risk-Adjusted Florida Property-Catastrophe Rate-on-Line Index, the pace of rate reductions appears to have re-accelerated as of this year's June 1 renewal. This marks the sixth consecutive year of rate decreases in JLT Re's index.
We attribute it to the intense competition between traditional and alternative capital providers, and a recent vendor-model update that has lowered the expected loss estimates on certain natural catastrophe risks. We expect pricing to continue to fall by 0% to 5% into 2018. Even after Hurricane Harvey we maintain our forecast because we expect any impact on pricing to be limited to affected regions and policies.
As noted by Bender, the inflow of alternative capital, which continues to outpace traditional reinsurance capital growth, is fuelling competition in the industry and is expected to contribute to further rate declines at the January 2018 renewals season.
With this in mind, and the fact that reinsurers have had a hit from hurricane Harvey, we were keen to hear what prospects S&P sees for the ILS market at the January renewals.
Maren Josefs, said;
The supply of alternative capital continues to exceed the demand for the protection these assets can provide. ILS fund managers are seeking opportunities to deploy capital in the nat-cat space. Presently, damage from U.S. hurricanes is the predominant risk covered in the global ILS market. Typically, deals are oversubscribed and it's not unusual to see the issuance amount upsized, and simultaneously, pricing settle at the lower end of guidance.
ILS investors also have a competitive advantage over traditional reinsurers in that their cost of capital (long-term return) targets tends to be lower than reinsurer's WACC, allowing them to profitably assume risks at prices that would be uneconomical for the traditional players. Hence, we expect the ILS market to continue to assume risks that fit their investment risk and return profiles and potentially be able to provide additional protection to national and regional insurers if needed.
With regards to Hurricane Harvey, we expect insured losses to be spread among many national and regional carriers as well as their reinsurers which could include some ILS funds. Losses from Harvey are primarily from flood which is generally not covered on personal lines. At the moment, it seems that total losses by ILS funds are limited. In the absence of any further major nat cat losses, we expect the ILS market conditions to continue at the next renewal. This said, hurricane Irma could potentially be a good test for the market.
Competition in the sector is fierce, and rates continue to decline across the majority of business lines. David Masters discussed the impact this is having on certain regions and operating lines, highlighting some areas of particular concern.
Pricing in the global P/C reinsurance sector has been falling for several years across the board (albeit at a slower pace than previously), with seemingly no floor in sight. However, the length and depth of the current soft pricing cycle have surprised many market participants. These declines are primarily attributable to an abundance of reinsurance capacity and multiple successive years of modest insured losses. Furthermore, competitive pressures in the industry remain fierce, as cheaper alternative capital sources continue to enter the market and crowd out the traditional players, especially in lines exposed to natural catastrophes.
Since price declines are visible across the board, price reductions are more pronounced in Europe and Asia in property cat compared to the US. This is partly due to stronger price reductions in the US in the last years and somewhat higher headroom for reductions in Europe and Asia.
S&P provided the table below, which shows how prices have declined across the board.
With the more traditional lines of business coming under increasing pressure, reinsurers and also ILS players have been looking for opportunities elsewhere, including in cyber risk, one of the fastest growing emerging risks in the risk transfer industry.
Regarding the expansion into cyber, Bender explained how even in the soft reinsurance market, opportunities for disciplined growth do still exist. Added Bender:
Demand for newer lines such as cyber continue to grow in the wake of recent high-profile attacks, as cedents seek to manage exposures to these risks proactively. Currently, the global cyber insurance market is estimated to be $3 billion to $4 billion in gross written premiums. The market is dominated by North America, and we expect it to grow to about $14 billion by 2022.
However, this line of business faces challenges in underwriting and modelling exposures. Since we believe the reinsurance sector to benefit from strong enterprise risk management capabilities, we believe growth opportunities to be considered carefully taken into account the limitations of underwriting history and modelling experience.
As pressures in the global reinsurance market mount and events such as Harvey further stress the profitability of the sector without signalling a turn in the soft cycle, there's likely to be both winners and losers as the reinsurance industry undergoes significant transformation.
Masters underlined just this, explaining what companies might need to do to navigate the challenging environment in order to survive.
Against the weak business conditions, we believe, reinsurers are navigating through this environment with sophisticated enterprise risk management programs (NYSEARCA:ERM), robust capital adequacy, and still-rational underwriting, so far. Indeed, capital strength and ERM have proven to be the sector's saving grace from weak business conditions. As a result, S&P Global Ratings is maintaining its stable outlook on the global P/C reinsurance sector and its ratings on the majority of companies in it.
The winners will be reinsurers that maintain underwriting discipline, know when to contract and when to grow, lead in certain specialty products, offer tailor-made solutions to move up the value chain, and are able to match risk with the proper capital. On the other hand, losers will be those that chase the market, seek growth for the sake of growth, and are followers and write mostly commoditized type of products.
As weak business conditions continue to exert their Darwinian pressure, only those strong enough to adapt or evolve will survive.
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