Friday, September 22, 2017

Reinsurers look to Asia

Competition for reinsurance business in Asia is set to continue to grow more intense, as the pain being inflicted on the industry in the US forces greater diversification in search of more profitable opportunities.

Lower rates, broader terms, miserable investment returns and relentless pressure from alternative capital are all contributing to an environment that saw the reinsurance sector book an underwriting loss in 2016 with a combined ratio of 101. This is the worst performance in more than 10 years, excluding 2011 when the Japanese earthquake/tsunami and Thai floods caused significant catastrophe losses.

Even so, competition remains high. Dedicated reinsurance capacity was estimated at US$420 billion at the end of 2016, according to AM Best, with US$75 billion of that coming from third-party providers such as insurance-linked securities (ILS), which continue to attract investment thanks to the sector’s lack of correlation with other traditional asset classes.

This interest from alternative capital comes despite poor fundamentals. Across the overall reinsurance sector, return on equity (RoE) is languishing five percentage points below the 2013 figure at 8%, with Bermuda companies hurting the most at an RoE of just 6.8% in 2016.

The troubling issue for reinsurers is that these results occurred in a benign year, leading AM Best to worry about the industry’s resilience. “The reality of the current situation is that even a normal catastrophe year will expose the true ramifications of current market conditions,” the rating agency said in its reinsurance review this week. “An above average catastrophe year may be downright ugly.”

With two major US hurricanes already making landfall this year, and the size of losses not yet clearly understood, the industry may be headed for ugly.

Indeed, the situation may be even worse than it appears, as the competitive pressure faced by reinsurers is not only reflected in pricing — it has also been absorbed by more generous terms and conditions, which is less visible at the moment but may become all-too apparent in the event of a significant catastrophe year.

Even if the industry escapes 2017 relatively unscathed, AM Best has significant concerns. “If the reinsurance market is booking the accident year combined ratio at a loss in a relatively benign catastrophe year, and that in and of itself is not the impetus for change, the next logical question is: What will it take to turn the market?”

As long as conditions remain strained, AM Best expects that mergers and acquisitions will continue to reshape the industry, not least because capital remains abundant, debt is cheap and organic growth is hard to come by.

Reinsurers that aren’t looking for a deal may seek to build income streams by working with alternative capital to identify opportunities in a market that is becoming increasingly challenging even for ILS.

The outcome of Brexit in the UK and Trump’s tax reform plans in the US are adding to the market uncertainty. AM Best sees some opportunities to grow the reinsurance pie through cyber insurance and mortgage reinsurance, but there are significant risks there too — and probably not enough upside.

“The market headwinds at this point present significant longer-term challenges that industry players need to work through,” said AM Best. “We’ve said that the companies that are not proactive will not determine their own destiny.”

The strongest players tend to be those with the broadest books and the biggest geographic footprint — and that likely means an increasing focus on Asia in the future.

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