A traditional soft market is in the cards as alternative capital-driven pricing pressure in the reinsurance market flows to the primary market, a recent Nomura report contends.
Nomura analysts Cliff Gallant and Mathew Rohrmann say in the report—titled "The Evolution of Reinsurance: Soft Market to Spur M&A"—that one impact of the growing alternative-capital presence will be further price weakening in property/catastrophe reinsurance rates, followed by weakening across all reinsurance lines before finally affecting primary-commercial rates.
"We have already seen a slowdown in primary-commercial rate increases despite the ongoing pressure of a low-investment-yield environment," the report states. Further, Nomura expects that the availability of cheap reinsurance will exacerbate the fight for market share at the primary level, leading to a traditional soft market.
Additionally, the analysts expect consolidation as the traditional reinsurance business model comes under pressure, stating that many reinsurers may need to merge to survive: "Eventually, companies that we may not yet think of as buy/sell candidates will take part. The pressures of a bad soft market cannot be understated, in our view."
The report ties this outlook to Endurance Specialty Holdings' attempt to buy Aspen Insurance Holdings, stating the attempt "makes perfect sense, by our view of the world. Endurance is small and, in our opinion, could end up on the selling side to survive unless it acts quickly to grow and diversify."
The reinsurance market is not just under pricing pressure, but also is experiencing an evolution in the marketplace. "In the evolutionary process," the report states, "things happen slowly before they happen very fast."
Nomura points out that the first catastrophe bonds were issued two decades ago, yet only recently has the alternative market shaken up the industry. "Much like what happened in the 1990s to the publicly traded U.S. domiciled reinsurers (none is left), we expect that a more efficient business model will force change in the reinsurance industry."
The advantages for buyers are clear, Nomura maintains: "As a risk-management product, cat bonds are less expensive than traditional capacity and are fully collateralized."
Alternative capital is pressuring property/catastrophe rates the most, with rates already down double-digit percentages since 2012 "in what appears to be a traditional soft-market free fall," the report adds.
Potential "wild cards" that could change Nomura's outlook include a major loss event, which would open up questions of reserve and balance-sheet quality and could derail activity. When asked by NU if investors who are bringing all of this capital into the reinsurance market will stick around should a major loss event occur, Gallant said that is the big question: "I think so, yes. They seem to be sophisticated investors, aware of the risks they are taking."
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