No reason to expect a hardening of the market anytime soon

For anyone waiting for the underwriting market to harden, it would appear they’ll be waiting a little while longer.

One of the events that can trigger a tightening of the primary market is a tightening of the reinsurance market. Two reports published earlier this month suggest that no such tightening is on the horizon.

According to a statement from Willis Group Holdings, the downward pressure on reinsurance rates has continued across almost all lines of coverage and across most of the globe. The downward pressure on rates has been accompanied by more generous terms and conditions. In other words, reinsurers are offering more coverage and lower prices all at the same time. According to the Willis report, the international reinsurance market remains overcapitalised creating the condition where the supply of reinsurance capacity outstrips demand. Willis Re CEO, John Cavanagh, is quoted as saying ‘Arguably, the continued lack of demand and oversupply of capital can only keep driving pricing down’.

Adding to their woes, traditional reinsurers face increasing competition from capital markets in the form of sidecars and catastrophe bonds. As the name implies, catastrophe bonds are associated with the risk of short-tail, natural catastrophes. The risk and return of a sidecar is tied to the results of a book of business. Together, these financial instruments offer primary carriers an alternative to the traditional reinsurance market. For their part, institutional investors view sidecars and catastrophe bonds as a way to diversify their investment portfolio and as a way of earning better returns at a time when interest rates remain at historical lows and the performance of stock markets has been disappointing.

As noted in the Willis Group statement, the current conditions in the global reinsurance market have led to an up-tick in mergers and acquisitions activity as companies have come to the realisation that ‘any further delay is only likely to see further deterioration in their valuations’.

The statement from Willis Group was followed by a report from A.M. Best. The report, entitled Global Reinsurers: Who Will Gain Despite All the Pain?, cited the overcapitalisation of the global reinsurance market as a reason for reinsurers to become more disciplined in their underwriting. The report predicts that 2015 will see companies further reducing their exposures in classes of business where they have not done well and expanding their exposures in those classes of business that seem to offer better opportunities. Having said that, the report notes that ‘companies that write predominately reinsurance and focus on underwriting are in danger of reducing their books of businesses to levels that may render them less relevant in the market, which could lead to more merger and acquisition activity’.

As cited in the A.M. Best report, the downward pressure on reinsurance pricing is expected to continue throughout 2015.

There is no law that requires insurers to take their cue from the reinsurance market. However the cost of reinsurance protection, in whatever form it takes, represents a significant portion of an insurer’s cost structure. In the absence of upward pressure on those costs, indeed in the presence of downward pressure, there is no reason to expect a hardening of the property and casualty insurance market anytime soon.