Analysts at Berenberg expect to see higher future profitability for the reinsurance sector as the hard pricing environment looks to set persist and deliver higher returns on capital for reinsurers.
The investment bank said that its broader view on reinsurance remains positive as the repricing of property catastrophe reinsurance has led to multi-decadal rate rises and much improved returns.
This is best demonstrated by the near all-time high spread on alternative capital of 10.5%, versus 5.2% 23-year average, which, in Berenberg’s view, is a leading indicator of higher future profitability for reinsurance.
“Our work has led us to believe that this cycle has indeed legs to run, and thus our stance remains positive overall for the sector,” analysts at Berenberg said.
“The current unwinding of a decade- plus of ultra-low interest rates, in conjunction with an increasingly higher nat-cat environment, layered with persistent inflationary pressures, suggest that upwards pressure on reinsurance pricing should persist and that the price of risk will stabilise at a new, higher level.”
Although Berenberg believes there will be an increase in capital raising and deployment over the course of 2023, it suggests that the magnitude will not be of the scale required to put significant pressure on rates.
Thus far, only $4.2 billion of capital was raised between Q4 2022 and Q1 2023, in part due to the subdued appetite from alternative capital investors following consecutive years of poor results.
Also, it notes the opportunity cost of capital is now much higher, with the two-year US treasury yield at around 4%, which has raised the threshold for expected returns on taking underwriting risk, and means that reinsurance pricing has to stay attractive for a rational investor to participate.
Furthermore, Berenberg points to a structural mismatch given the lack of supply of capital and increased demand as capital is down 5% on an economic basis and 16% on a GAAP basis, while exposure growth was 13% in 2022.
“We expect the demand for (re)insurance coverage to continue to increase, as inflation drives higher values for assets, which puts more pressure on rates,” Berenberg concluded.
“Consequently, we anticipate that the hard market will continue throughout 2023 and into 2024. Although we anticipate rate rises to slow down into 2024, we do not expect a material deterioration to the new base level of pricing, which raises the prospect of higher returns on capital for reinsurers.”
