RoE squeeze, capital down – Willis Re - FREE

RoE squeeze, capital down – Willis Re - FREE

John CavanaghCapital among traditional reinsurers was down to $357bn at year’s end 2015, according to a report from Willis Re.

The industry capital figure was $13bn higher at the end of 2014 “as opportunities for acceptably profitable capital deployment remain challenging”, said the reinsurance broker in its latest Reinsurance Market Report.

That contrasts with continued growth reported in non-traditional capital, which hit new heights of $70bn at the end of 2015, thinks Willis Re.

Taking the alternative capital influx into account, the industry total stands at $427bn.

RoE squeeze

Pressure continues to build on return on equity (RoE) to shareholders across the 38 reinsurers in the report’s index, noted Willis Re.

In 2015, the index returned $23.3bn to shareholders, representing 77% of their net income, down from $20.4bn in the previous financial year.

“According to the report, companies within the Index providing catastrophe loss and prior year reserve release disclosure continue to show a seemingly healthy aggregate reported RoE of 10.2%, albeit down from 11.5% in 2014,” said Willis Re.

 “However, based on a more typical catastrophe loss year and excluding prior year reserve releases, aggregate RoE would diminish to just 3.4%, down from 5.8% in 2014,” the broker added.

Willis Re noted that there was $5.5bn of share buybacks, down from $7.8bn year-on-year, while $17.8bn was returned to shareholders through ordinary and special dividends, versus $12.6bn in 2014.

 A significant rise in expense ratios over several years is a major factor eroding RoEs, according to the study.

Expense ratios for the 38 firms deteriorated by approximately four percentage points to 33.1% between 2007 and 2015, going up by one percentage point in 2015.

The broker attributed this to reinsurers’ continued investment in underwriting and diversify their business portfolios, plus regulatory and associated governance costs.

“Reinsurers continue to face a myriad of headwinds placing downward pressure on underlying results. However, headline figures remain robust and capital positions are strong – the dual saviours of reserve releases and low severity loss experience continue to underpin reported results,” said John Cavanagh (pictured), global CEO of Willis Re.

“Yet underlying RoEs are now beginning to breach minimum target thresholds. The pressure persists with capital remaining at record levels amidst the continued influx of capital from non-traditional sources,” said Cavanagh.

“Given the current climate, the broadening of reinsurer business models is proving a successful strategy for many and increasing relevance to clients, despite the impact on expense ratios. But ultimately, reinsurers will yet again be looking to another below average loss year to maintain acceptable results,” he added.

Sidecar capital

The trend of reinsurers using sidecars to harness alternative capital also formed part of the report.

Third party capital continues to be attracted to sidecar and managed capacity, giving traditional reinsurers access to additional capital beyond their own balance sheet.

Continued diversification by traditional reinsurers has resulted in a further increase in capacity provided by market-facing sidecars, as well as managed catastrophe bond funds, the report noted.

Hiscox’s Kiskadee Re fund, Validus Re’s AlphaCat vehicle, and Markel’s December 2015 CatCo acquisition were cited as major examples of third party capital sidecar fund growth.

“The boundaries between alternative and traditional reinsurance continue to blur; for example, the underwriting activities of these three ‘alternative’ vehicles are not fully consolidated in the financial statements of the sponsoring ‘traditional’ reinsurers,” noted the report.

The study added: “Against this trend of increasing managed capacity, Renaissance Re’s active capital management of DaVinci Re returned a net $100m of capital in January 2016. This was based on its assessment that the risk premium had fallen below adequate levels.”

The report noted that several internal retrocessional sidecars had expanded over the course of 2015 (see chart).

internal sidecars 2015

Renaissance Re was again a notable contrarian, having recently halved the capacity of its Upsilon internal sidecar from $175m to $87.5m.

Swiss Re has also drawn down its internal retrocessional vehicle; the three tranches issued by Swiss Re’s Sector Re V now total $190.7m down from a $500m peak several years ago.

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