Reinsurance companies continue to face pressures from many sides.
Capacity from both traditional and alternative sources is bringing record amounts of funds into the marketplace; rates are decreasing because of a lack of costly catastrophes; and primary insurers, themselves flush with capital, are altering the way they think about and even purchase reinsurance, retaining more risk and looking to reinsurers for expertise and unique products rather than just capacity.
Reinsurers are adjusting to this changing landscape with portfolio diversification and through consolidation, as buyers seek to gain size, scale and a greater range of products and services to offer clients.
Experts generally agree that these new market realities may be here to stay for the foreseeable future, and that the pressures and responses could inspire a longer-term marketplace transformation.
As A.M. Best recently put it, the changes could be "structural" rather than "cyclical." Some industry heavy hitters agree. In its September Global Reinsurance Segment review, "The New Reality," A.M. Best notes that Berkshire Hathaway Chairman and CEO Warren Buffett recently told shareholders that the reinsurance industry in the next 10 years "will not be as it has been in the last 30."
But what is the reinsurance industry transforming into, and what will the companies that successfully adapt ultimately look like?
"I think in the future we'll see fewer market participants, and those that remain will have more scale," says Bill Donnell, president, U.S. P&C, Swiss Re. "Size matters in reinsurance."
Donnell's prediction matches up well with the current mergersand acquisitions activity taking place in the reinsurance industry — activity that is expected to continue as reinsurers adapt to the increased levels of capital and capacity available in both the reinsurance and primary markets. But while companies appear to see the value of size and scale in this new marketplace, how they leverage those factors may be what separates the winners from the losers.
"At the end of the day, what matters is what you can do with the company you buy," says Steve Levy, president, Reinsurance Division, Munich Reinsurance America Inc. The major players can already offer any capacity that the market demands, he adds, but in addition to that, "the important thing in the future will be the know-how, products and service, and innovative solutions that a reinsurer can offer."
It's about meeting the changing demands of purchasers of reinsurance, explains John Welch, chief executive of XL Catlin's North America Reinsurance operations. "The needs of cedents are clearly changing," he says. "In most developed markets, cedents have narrowed their panel from what used to be as many as 100 reinsurers to more like 10 or 20. In general, they want to work only with reinsurers that can engage with them on a global basis across their entire suite of reinsurance protections."
Essentially, while success depends on offering the innovation, range of products and expertise that buyers demand, it takes a certain size and scale to do that effectively. "The reinsurance companies best prepared to deal with the changing landscape are the ones that marry scale and innovation," adds Welch.
It is a strategy he is counting on after his company's own high-profile merger to gain that scale and reach. "We were one of the first, leading this [M&A] trend when XL Group and Catlin Group officially united on May 1, creating the eighth-largest reinsurer globally," Welch says.
Industry professionals and observers agree that M&A will continue among reinsurers, and an April Willis Re market report suggests that as the pool of potential partners shrinks, "aspiring consolidators" are growing concerned about "missing out on what many observe as a generational change in the industry."
Most experts don't expect the activity to have any short-term impact on the marketplace, though. "Within the reinsurance sector, consolidation is occurring mostly among smaller companies, so we can expect there will be stronger market players in the future," says Levy. "This will have less of an impact on competition in the short term, but in the medium term it may result in greater price stability and therefore be good for the market."
Lara Mowery, global head of Property Specialty at Guy Carpenter, sees the same as far as placing coverage. "We haven't really seen any significant impact, in the way we're able to place reinsurance for clients, from the M&A activity," she says, adding that Guy Carpenter does have to be aware of which companies unite, what their new philosophy will be and how that will affect clients.
The pricing picture
The good news for reinsurers is that price declines appear to be moderating somewhat, even if capacity remains high and competition continues to be fierce. "In general, we've seen signs that pricing is leveling off," Donnell says. "That's important, because margins have been depressed — and in order to provide long-term support, leveling off was needed."
Although it would be premature to call the current environment a "bottom" with respect to pricing, says Welch, "we believe that we are nearing the bottom and heading toward a more stable pricing environment for 2016."
With plenty of capital and capacity in the property marketplace and relatively benign losses, reinsurance rates had been falling steadily until recently. But Guy Carpenter's "Mid Year (Re)Insurance Report" notes, "Continuing the trend at June 1, price declines moderated somewhat, particularly on programs covering U.S. wind." The report adds, "While capacity is still plentiful and low loss experience continues, many reinsurers held the line against the more extreme declines."
Mowery at Guy Carpenter says that as reinsurance pricing comes down, there is more alternative capital available that hasn't entered the market just yet, "so the fact that returns have moderated has had an impact."
Indeed, the biggest driver of the changing marketplace remains the influx of alternative capital, mostly provided by pension funds, hedge funds and sovereign wealth funds. Most experts agree alternative capital is here to stay, but a few factors could influence which type of investor stays and which exit the market.
Many of these investors, for example, have not yet had to respond to a significant catastrophe event. "If a significant cat event occurs, we don't know how these markets are going to respond," says Tom Highet, president of Maiden Re. "Having said that, if a significant cat event occurs there's also probably going to be some hardening of pricing in the marketplace, and there are possibilities of new capital coming in at that point in time."
While experts agree this capital has shown little interest in dipping into the longer-tail casualty lines, it has still impacted rates in those lines.
Mowery notes that as alternative capital impacts property catastrophe, reinsurers seeking to diversify their portfolios have brought capacity, and therefore competition to casualty lines. "Capital is abundant throughout the reinsurance space, so it's not just property seeing excess capacity, it's virtually all lines of business and virtually everywhere in the world," she says. "Even though most of that capital is deployed in property catastrophe, the entire industry is seeing that impact."
Donnell sees opportunities in the casualty market, stating, "It's an exciting time in the casualty space due to all the technological advancements at play." While there are challenges, and plenty of capacity available, Donnell believes, because of the longer-tail exposure, insurers are typically looking for "a reinsurer that will be in this segment for the long haul."
"We expect the general environment to be mainly unchanged," says Levy. "Competition should remain intense as long as there are no extraordinary loss events or other major market upheavals. However, the pressure on prices should ease still further, after two years of price deterioration."
Opportunities and adaptation
The market of the future isn't just about consolidation; it's also about new opportunities. Excess capital and capacity may be driving competition, but they also allow the industry to consider coverage solutions for previously untouchable risks.
"There is a tremendous number of uninsured or underinsured risks globally," says Mowery. "And when you look at a reinsurance market that's maturing, has an abundance of capacity and has an incredible amount of talent and creativity in it, there's a great potential to look at solving a lot of those problems that five years ago would have been very difficult, because the capacity and the ability to respond to some of those events just really wasn't there. And the price effectiveness of being able to provide solutions wasn't there."
Now, she says, pricing has reached a level that "makes these conversations more plausible and realistic." Mowery mentions U.S. flood risk, "which for years has been considered uninsurable in the private sector outside of excess flood. Now people are looking into private solutions to take on that risk, and reinsurance capacity is there to back up that kind of thinking."
A.M. Best's "New Realities" report sees a market emerging in which returns are less impressive and profits depend more on underwriting. But companies can find "significant success," the report adds, if they can offer the right products, diversify, walk away from bad business and "take advantage of the new 'cheaper' capital coming into the market by investors that may not have the reinsurance and underwriting expertise" that reinsurers possess.
Levy's view on the best opportunities for reinsurers today: "Providing clients with advice in the areas of underwriting, claims and product development, as well as customized reinsurance solutions designed to address their specific risk and capital management needs. These are and will continue to be the decisive success factors in the reinsurance market."
How will alternative capital affect rates,post-disaster?
In a WillisWire blog post, Bill Dubinsky, managing director for Willis Capital Markets & Advisory, writes, "We will not know the outcome for certain until the next game-changing event hits, but we do know that investors are realistic and have an understanding of what the impact of a major event, or series of major storm events may have. …They understand the risk models may not be 100% accurate, and therefore larger and currently unmodeled losses could occur."
John Welch, chief executive of XL Catlin's North America Reinsurance operations, says alternative capital could prevent some of the typical post-event hardening of rates when a catastrophe occurs. "I am of the opinion that alternative capital will continue to play a role after a large event," he notes. "This should serve to dampen the upward movement in pricing that is historically caused by shortfalls in capacity after an event."
The type of a loss event, rather than the size, could influence some investors, says Bill Donnell, president, U.S. P&C, Swiss Re. "If we see an event that's different than what was expected by the models, then that might have a bigger impact."
Just as investors came into the reinsurance market as a response to economic realities, some may move out again if interest rates rise and other investment opportunities arise. "More capital will leave following a larger increase in rates, particularly if the inflation rate remains stable so that real rates of interest increase, making traditional fixed-income investments more attractive to institutional investors," says Steve Levy, president, Reinsurance Division, Munich Reinsurance America Inc.
Whatever the future is for alternative capital, reinsurers are adapting and executing strategies that work for them. Given their views that the successful reinsurers of the future will need to look beyond just providing capacity to succeed, it makes sense that their strategies mostly involve offering that extra value to clients.
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