Darken­ing out­look

Six months into 2014, bond credit rat­ing agency, Moody’s In­vestor Ser­vices pub­lished its in­dus­try out­look for rein­sur­ance. In the re­port, the com­pany down­graded its global rein­sur­ance out­look from sta­ble to neg­a­tive. An in­dus­try that started the year unde

RISKSA Magazine - - CONTENTS - Do­minic Uys

Ac­cord­ing to Kevin Lee, se­nior credit of­fi­cer at Moody’s, the com­pany’s change in out­look mid­way through the year, was prompted by a num­ber of fac­tors that are ex­pected to put in­creased stress on rein­sur­ers in the com­ing 12 to 18 months. While many of these in­flu­ences have been de­vel­op­ing over the course of re­cent years, Lee in­di­cates that the in­dus­try is now reach­ing a turn­ing point. The in­flux of al­ter­na­tive rein­sur­ance ve­hi­cles in the form of in­sur­ance- linked se­cu­ri­ties and tra­di­tional catas­tro­phe bonds is of par­tic­u­lar con­cern to the en­tire rein­sur­ance mar­ket in the de­vel­oped world. “Tra­di­tion­ally rein­sur­ers have re­lied on their catas­tro­phe lines to cross- sub­sidise their other, less prof­itable lines. A smaller cat mar­ket will mean that rein­sur­ers need to start look­ing at other means of sup­port­ing these lines,” Lee says. The ef­fect on de­vel­op­ing mar­kets is much the same as the sup­ply of rein­sur­ance ca­pac­ity en­ter­ing the de­vel­oped world, and as a re­sult, be­gins to out­strip de­mand. Ac­cord­ing to Lee, the soft­en­ing global mar­ket for rein­sur­ance shows sim­i­lar­i­ties to the state of the mar­ket around twenty years ago. Bar­ring a ma­jor event like the Septem­ber 11 at­tacks, this could in­di­cate dif­fi­cult times ahead for rein­sur­ers.

His­tory re­peat­ing

Lee notes that the cur­rent rein­sur­ance mar­ket cy­cle bears a strik­ing re­sem­blance to the state of the in­dus­try in the late 1990’ s. “There is an over­abun­dance of sup­ply at the mo­ment. We have tra­di­tional rein­sur­ance of­fer­ings com­pet­ing with sev­eral al­ter­na­tive ve­hi­cles such as in­sur­ance- linked se­cu­ri­ties. Pric­ing has de­clined no­tice­ably year on year and the power of buy­ers to bar­gain for re­duced pric­ing, has grown,” Lee says. The con­di­tions may be sim­i­lar but, ac­cord­ing to Lee, the driv­ers be­hind these sim­i­lar­i­ties are quite dif­fer­ent from the ones in the past. Pre­vi­ously high in­ter­est rates and a strong stock mar­ket re­sulted in loose un­der­writ­ing by in­sur­ers. Less strin­gent con­straints on in­sur­ers also al­lowed for more ag­gres­sive un­der­writ­ing lever­age. To­day’s con­di­tions are the ex­act op­po­site but the re­sult is the same. More strin­gent leg­is­la­tion around in­sur­ance has re­sulted in much more care­ful un­der­writ­ing and the de­pressed stock mar­ket has mo­ti­vated in­sur­ers to seek meth­ods of re­duc­ing their rein­sur­ance spend.

Tip­ping the scales

Lee states that there are a num­ber of fac­tors that can swing the out­look for the rein­sur­ance mar­ket in ei­ther di­rec­tion. How­ever, even if some of these swing fac­tors oc­cur, they could still push the rein­sur­ance mar­ket in ei­ther di­rec­tion. Lee tells RISKSA that the dras­tic price de­crease in rein­sur­ance prod­ucts over re­cent years is ex­pected to slow sig­nif­i­cantly. How­ever, a fur­ther 15 to 20 per cent drop in catas­tro­phe prices over the next year is not an im­pos­si­ble sce­nario. This would bring prices down to below 2001 lev­els and some rein­sur­ers may need to re­vamp their cap­i­tal struc­tures if they want to con­tinue earn­ing their cost of cap­i­tal. Se­condly, a rise in in­ter­est rates would pro­vide more clar­ity on how much of the non- tra­di­tional cap­i­tal that has flowed into the mar­ket will have any stay­ing power. “Our work­ing as­sump­tion is that many of these in­vestors are equally mo­ti­vated by di­ver­si­fi­ca­tion and there­fore would likely stay when in­ter­est rates rise. Higher in­ter­est rates would boost rein­sur­ers’ in­vest­ment in­come, which would be credit pos­i­tive, but

“With buy­ers bundling higher vol­umes of risks in their rein­sur­ance pro­grammes and con­sol­i­dat­ing panels, rein­sur­ers that can pro­vide sub­stan­tial ca­pac­ity have an ad­van­tage over small rein­sur­ers”

may also en­cour­age some rein­sur­ers to sell prod­ucts at below cost to hang onto mar­ket share,” Lee re­ports. One fac­tor that could shift the mar­ket into a hard­en­ing cy­cle is a size­able catas­tro­phe event. Ac­cord­ing to Lee a ma­jor loss, par­tic­u­larly in Florida could scare off some non- tra­di­tional cap­i­tal, es­pe­cially if the loss un­der­mines con­fi­dence in the cat mod­els. The op­po­site may also oc­cur and the prospect of higher prices could trig­ger an in­flow of new money “Our work­ing as­sump­tion is that many in­vestors would not walk away af­ter one bad year given the good his­tor­i­cal per­for­mance of cat bonds and ILS funds. ILS funds are com­ing off their fourth best year since 2006, hav­ing de­liv­ered a 7.67 per cent re­turn last year, net of fees, ac­cord­ing to the Eureka­hedge/ ILS Ad­vis­ers In­dex,” Lee states A large catas­tro­phe event would test the abil­ity and will­ing­ness of non- tra­di­tional providers to hon­our their obli­ga­tions in a man­ner that meets buy­ers’ ex­pec­ta­tions. A large loss would also test their con­tract pro­vi­sions, in­clud­ing col­lat­eral re­lease mech­a­nisms. Such a test could ei­ther le­git­imise non- tra­di­tional ca­pac­ity as a re­li­able coun­ter­party or raise doubts about its value propo­si­tion.

The year to come

In spite of the neg­a­tive rat­ing, Lee says that the rein­sur­ance may well see some lim­ited pos­i­tive up­swing in the com­ing year. “It is un­likely that we will see rein­sur­ers go­ing un­der in the com­ing year, but we could see a no­tice­able re­duc­tion in the ca­pac­ity of many,” Lee says. Lee be­lieves that the rein­sur­ers who will best be able to cope with these chal­lenges of the com­ing 18 months will have a num­ber of traits. Firstly, rel­e­vant size will be an im­por­tant fac­tor. “With buy­ers bundling higher vol­umes of risks in their rein­sur­ance pro­grammes and con­sol­i­dat­ing panels, rein­sur­ers that can pro­vide sub­stan­tial ca­pac­ity have an ad­van­tage over small rein­sur­ers. Go­ing for­ward, a rein­surer may need at least US$ 3- 4 bil­lion of cap­i­tal ( in­clud­ing the cap­i­tal it man­ages via side­cars and other in­vest­ment ve­hi­cles) to be viewed by buy­ers and bro­kers as long- term strate­gic part­ners,” Lee states in his re­port. Rein­sur­ers with proven track records, hav­ing al­ready paid their dues with clients are also bet­ter placed. Ac­cord­ing to Lee, cur­rent mar­ket con­di­tions favour rein­sur­ers that have al­ready es­tab­lished them­selves as strate­gic part­ners with clients and demon­strated their value through ad­di­tional ser­vices like data qual­ity as­sess­ments and model tear­downs.

Sim­i­larly, rein­sur­ers with a track record of pay­ing claims promptly, man­ag­ing col­lat­eral re­lease mech­a­nisms fairly, pro­vid­ing cash ad­vances to clients vol­un­tar­ily, and re­solv­ing cov­er­age is­sues rea­son­ably are more likely to dif­fer­en­ti­ate them­selves from non- tra­di­tional cap­i­tal providers. The grow­ing trend among in­sur­ers is to re­duce their rein­sur­ance spend by con­sol­i­dat­ing lines or bundling their in­sur­ance risks. Rein­sur­ers that have ex­per­tise in mul­ti­ple prod­ucts and mul­ti­ple ge­ogra­phies have a bet­ter chance of dif­fer­en­ti­at­ing them­selves from com­peti­tors with more lim­ited prod­uct sets. Sim­i­larly, this flex­i­bil­ity will also set the rein­sur­ers apart from non- tra­di­tional ser­vice providers.

African per­spec­tive

Ju­nior Ngu­lube, CEO of Mu­nich Re of Africa tells RISKSA that the year has so far gone ac­cord­ing to the com­pany’s ex­pec­ta­tions. “It is quite early to com­ment but so far we have been mak­ing some good strides in reach­ing the goals we set out at the start of this year,” he starts. In Jan­uary of this year, Ngu­lube ex­plained to RISKSA that Mu­nich Re of Africa would take mea­sures to make up for the anaemic per­for­mance of the pre­vi­ous year. Among these was a re­newed fo­cus on in­fra­struc­ture projects on the African con­ti­nent. “So far we’ve seen a lot of move­ment on trans­port and power in­fra­struc­ture projects, and we are quite op­ti­mistic about devel­op­ment in Africa,” he says. “We also see quite a few in­sur­ers work­ing to re­duce some of their rein­sur­ance spend but it is to be ex­pected in a mar­ket that is mak­ing ef­forts to be­come more ef­fi­cient. As rein­sur­ers we should adapt to sup­port this mar­ket,” he adds. As far as the move­ment of rein­sur­ance ca­pac­ity into the de­vel­op­ing mar­ket of Africa goes, Ngu­lube tells RISKSA that change is still slow. “Even though boom­ing economies like Nige­ria and Kenya do of­fer new op­por­tu­ni­ties, South Africa re­mains the largest mar­ket for both in­sur­ance and rein­sur­ance. This prob­a­bly will not change very soon,” he states. Ex­treme weather events like the ones that hit Gaut­eng at the end of last year are still in the back of every­one’s mind, and Ngu­lube says that the in­dus­try should ex­pect more to come. The rest of 2014 has been rel­a­tively quiet how­ever. “The year isn’t over and we can still see some se­ri­ous weather later on,” he adds. Ngu­lube admits that the mar­ket is still some way away from mak­ing a full re­cov­ery but he adds that Mu­nich Re of Africa re­mains op­ti­mistic about what the rest of 2014 will bring for the com­pany.

Newspapers in English

Newspapers from South Africa

© PressReader. All rights reserved.