Analysts at investment bank Berenberg are highlighting the potential for a “reinsurance mega trend” period of sustained earnings growth to emerge that overshadows the more typical cycle, but warns that expansion of alternative capital and the interest of institutional investors such as pension funds could prevent this occurring.
In meetings with investor clients, the Berenberg analyst team has been discussing “the view that reinsurance is on the tip of seeing a mega trend of sustained earnings growth, overshadowing the usual cyclicality in this sector.”
The drivers of this potential reinsurance mega trend are seen as the sector’s “oligopolistic structure” and the rising barriers to entry, in terms of minimum risk capital required.
As well as the increasing burden from natural catastrophe losses over the last decade, plus the losses being seen from what were once deemed secondary perils, such as wildfires, as evidenced with the recent California event.
Previously, the Berenberg analyst team said that the California wildfires may result in a firming of reinsurance pricing, as the quantum of losses faced by the global insurance and reinsurance industry may be both significant and unexpected enough to drive some market disruption and capital erosion.
On the rising levels of catastrophe loss being seen, Berenberg analysts had also said previously that these are now absorbing excess capital from the reinsurance system.
While the full financial effects of the wildfires remains uncertain and insurance industry loss estimates still have a particularly wide range, from roughly $30 billion to as high as $50 billion, it’s clear this has been a particularly meaningful event for the sector and will potentially change sector views on natural catastrophe risk (for that peril at least).
Whether it is sufficiently severe, in terms of its effect on capital and risk appetites, to drive any meaningful hardening remains uncertain. While it is also uncertain when the effects may be seen, in terms of at which renewals, and whether the fires could have a spill-over effect to reinsurance renewals in other regions of the world than US nationwide and California specific treaties.
The general feeling at this time is that US mid-year reinsurance renewals are likely to follow similar trends to January, being in a range from stable through to slightly softer (although with some cat loss affected outliers), but with terms and conditions continuing to hold reasonably steady.
The Berenberg analysts feel there is a chance the industry continues to remain disciplined on price and terms at this time, which would be the major driver for any coming reinsurance mega trend, in earnings terms.
Risk adequacy of rate for deploying reinsurance capital is certainly going to be more of a focus following the fires, and this should steel resolve in the face of what had been expected to be a steady softening of the market.
The question being, whether discipline can outweigh appetites in the market for continued expansion in property catastrophe risks, given rates still remain at historically attractive levels and stricter attachment terms are driving a constant desire for growth.
Berenberg’s analyst team states, “The risks to our view include the increasing role North American pension funds play in providing alternative capital, which at H1 2024 accounted for USD113bn of the total USD760bn reinsurance sector capital (source Gallagher), and the usual cyclicality of the sector, with pricing down on a risk-adjusted basis at, we estimate, c2.5% at the January 2025 renewals.”
A circa 2.5% decline in reinsurance pricing at Jan 1 2025 was certainly not enough to dent appetites at this time, so it seems the Berenberg team once again see alternative capital and insurance-linked securities (ILS) investors as the main risk to this reinsurance mega trend of profitability emerging.
It is important to note two things.
First, those investors and ILS fund managers deploying collateralized capacity into traditional reinsurance and retrocession, as well as sidecars, are likely (in our view) to maintain similar rate needs as the traditional players. There seems greater alignment between these products and the traditional reinsurers at this time.
But the catastrophe bond market has been diverging somewhat, in terms of its pricing, as higher-layer and more risk-remote reinsurance structures that are securitized and so made liquid, have been soaking up much of the demand from investors (old and new) right now.
Allowing and perhaps enabling that slight bifurcation in pricing to persist, by taking advantage of the cat bond market for ceding out higher layers of reinsurance and retrocession towers, could actually benefit traditional reinsurers this time around.
Where in past cycles the traditional market has competed hard against cat bond capital, resulting in significant softening.
This time it might be prudent to maximise the use of it, so that alternative capital is satisfied with sufficient risk investment opportunities, and re/insurers can therefore benefit from efficient, multi-year capital to fill out their peak higher-layer catastrophe protection needs.
By embracing rather than competing with the catastrophe bond market, there is perhaps more of a chance the traditional re/insurers get to enjoy a mega trend and sustain that for longer.
A bifurcation of risk-adjusted return requirements, driven by efficiency of and lower cost-of-capital, should perhaps be seen as a positive, rather than something that must be competed against.
Some insurers and reinsurers seem to appreciate this opportunity, laying off increasing amounts of their towers to alternative capital, at the layers where the capital markets can be most efficient and so the pricing is most attractive.
Which allows those underwriters to concentrate on profiting from still-harder pricing on the inwards side and across mid to lower layers, while growing into diversifying and complementary specialty and casualty business lines.
Whether a mega trend is on the cards in reinsurance, or not, there is certainly evidence that if the industry wants to maximise the opportunity that catastrophe bonds present, as a risk transfer tool and also a way to leverage relationships with investor partnership capital, now (for many reasons, including the expansion of the ILS investor base) may be the time where this opportunity is at its greatest.
