Monte Carlo analysis

MCIt’s a business whose prospects have turned for the worse and there is not much we can do about it - Warren Buffett (May 2015)

In the run up to the annual reinsurance conference in Monte Carlo, many of the industry's most thoughtful commentators take stock of the current market and opine on what might happen next. The first charts and analyses have come from the rating agencies that closely follow the sector.

The reports from AM Best, S&P and Fitch echo Warren Buffett's comments earlier in the year and describe an industry that has undergone structural change as capital has found new ways to finance the industry.

The agencies have maintained their negative outlooks on the sector. They warn that rates could continue to soften whilst losses are likely to return to their long term averages. They predict that the largest players will be best placed to adapt to the new normal, stoking the fire for yet more M&A activity in the coming months and years.

AM Best

Report: “It is Not Your Father’s Reinsurance Market Anymore” – The New Reality

Sector outlook: Negative

Quotes:
- Ease of entry and exit, among other things, is key to reinsurance risk functioning like a tradable asset class. Ultimately that seems to be the end game, conceivably for all reinsurance risks, to be able to wake up in the morning, wait for the market to open, and trade in or out of various pools of reinsurance risk – even if there was an event the night before.

-  Pricing to the levels seen after Hurricane Andrew may be a thing of the past, relying on double digit yields to deliver double digit ROEs may also not be seen again during the career span of anyone working today.

- At this year’s annual shareholders’ meeting, Berkshire Hathaway Chairman and CEO Warren Buffett stated “It’s a business whose prospects have turned for the worse and there is not much we can do about it.” He added that the reinsurance industry in the next ten years “will not be as it has been in the last 30”.

- The shift from reinsurance to primary business has been on the uptick over the past couple of years given that pricing for reinsurance has declined in the double digits every year for the past 3 years and reinsurers increasingly seek to get closer to the source of risk.

Charts:

Top 10 reinsurers by 2014 gross written premium

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Link: AM Best

Standard & Poor's

Reports: Discipline Is Necessary As Reinsurers Adjust Their Exposure To Catastrophe Risk; Reinsurance Shark Tank - Only The Strong Will Survive and Lessons From Large U.S. Cedants In the Game Of Reinsurance Arbitrage

Sector outlook: Negative

Quotes:
- As reinsurance markets soften, reinsurers' attitudes to catastrophe risk are diverging. Some reinsurers are putting their faith in taking on increased catastrophe risk, while others appear to be looking to expand in other lines of business.

- Two years of low claims have contributed to the current record high levels of capital in the industry and thus to the recent downward trend in catastrophe risk pricing.

- It is unlikely in the next 12 to 24 months that we will see profitability return to the strong levels of the past five years, that pricing will improve enough to turn the market across the board, or that competition will subside. In the meantime, for reinsurers, there seems to be a Darwinian concept at work, as only those strong enough to adapt or evolve will survive.

Charts:

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Link: S&P

Fitch

2016 Global Reinsurance Outlook: Fortunes Arise from Shifting Landscape and Market Pressure

Sector outlook: negative

Quotes:
- We do not view the reduced pace of price reductions reported for some bellwether lines in June and July 2015 renewals as a convincing signal that a price floor in the market has been reached...

- Soft market conditions will prevail, due to subdued reinsurance demand and fierce competition, especially where alternative capital and traditional reinsurers compete directly. Increased M&A activity will have a limited impact on abating supply-side competition.

- Fitch views the major Tier 1 reinsurers as among the winners of the changing reinsurance landscape. Conversely, small mono-line property catastrophe reinsurers, without other distinguishing attributes, remain most vulnerable to negative rating actions, through any protracted period of market price softening.

- A significant catastrophic loss event of USD70bn or more, coupled with significant unrealised investment losses from an abrupt jump in interest rates of 300bp or more could threaten the sector’s stable rating outlook.

- Fitch calculates that each 100bp increase in interest rates would result in a 5% decline in the reinsurance sector’s stated shareholders’ equity.

- But at an entity level, the agency maintains a cautious view on M&A, due to the execution and integration risks... It remains to be seen how successful the latest round of deals are in delivering increased value and what the optimal size for a specialist reinsurer will prove to be in the medium term... Mergers that are perceived to be poorly constructed face a number of challenges not least from reinsurance buyers that may be reluctant to place business over the longer term.

Charts:

Reinsurer M&A activity

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Return of equity

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Link: Fitch

Posted: Monday, September 7th, 2015