Editor's comment: Reinsurers' sleight of hand - FREE

Editor's comment: Reinsurers' sleight of hand - FREE

playing cardReinsurers are adept at making the most out of a bad hand. Their regular results statements are a great example of this, particularly while they have capital to fall back on. 

However, a recent report from Willis Re highlighted what has been known for some time: underlying return on equity (RoE) for reinsurers has reached an anaemic 3.4%, according to the market update published in April.

The reinsurance broker arrived at that moribund figure from a focus group of 38 leading reinsurers, by adding on the effect of a more typical catastrophe loss year, to counteract the sector’s sheer good fortune in recent years in not facing bigger hurricane losses, which if the industry’s luck changes, might yet drag RoEs down to a new nadir.

The underlying RoE also stripped out reinsurers’ cherished ability to factor in prior year reserve releases – the proverbial Ace card kept up reinsurers’ sleeves. Such sleight-of-hand is of course the industry norm, and increasingly essential to turn around what would otherwise be a bad or mediocre hand.

Trawling through results to weed out the small print of just how much “favourable development on prior year reserving” has been released to conjure the headline profit figures at the top of results statements is also the norm, as the first quarter results begin to trickle in.

The aggregate underlying RoE figure has certainly deteriorated. The 3.4% figure for 2015 was down from 5.8% in 2014, the broker calculated. That is set against the “seemingly healthy” reported RoE of 10.2% for 2015 across the reinsurers in Willis Re’s index. That figure was also down from 11.5% in 2014. In total, Willis noted $23.3bn returned to shareholders, amounting to 77% of the reinsurers’ net income.

“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,” noted John Cavanagh, global CEO of Willis Re, suggesting the sleight of hand show can continue for the foreseeable future, particularly if the industry’s luck holds.

 The other headline from the Willis Re report is that the traditional reinsurers’ capital was down slightly, by $13bn from the previous year, to $357bn at the end of 2015. That contrasts with continued growth in non-traditional reinsurance capital, which hit new heights of $70bn at the end of 2015. With the alternative competition constant and increasing, the twin saviours of reserve releases and low losses are going to be continually relied upon, until one or both runs out.

Back in February, Ulrich Wallin, Hannover Re’s chairman and CEO, argued that the reinsurance market is still cyclical and tends to harden when the RoE drops below 5% amid major loss activity. “Each time that happened the average RoE of the industry fell below 5% and each time rates then increased,” said Wallin.

If the market was no longer cyclical, Wallin argued that the sector should be a lot more afraid of the pricing falls experienced in recent years. “If that movement continues without the cyclical uptick then, of course, there is not that much of a rosy future for the reinsurance market,” he warned.

Previous cycles were kept turning by volatility from major loss events, he noted. However, what is different in today’s market is the alternative capital in reinsurance. That $70bn – almost all invested in reinsuring the property catastrophe peak risk which is traditionally relied upon for a market turn – was simply not there in previous cycles.

Wallin acknowledged that the industry is enthusiastically engaged in “the cheating phase” with its reserve releases. What happens when individual reinsurers run low – if they approach the 5% mark with their reported RoEs; if their underlying RoEs shrink to nearly nothing; and if alternative capital continues to stymie price rises in the cycle-driving peak catastrophe business – is a big question for the future health of reinsurance.

By David Benyon - dbenyon@euromoneyplc.com

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