In the current buyer’s market environment, international financial services rating agency Standard & Poor’s (S&P), has highlighted how commercial insurance players are making the most of market conditions and reinsurance arbitrage.
Driven by intense competition from both traditional and alternative reinsurance sources, the benign loss experience and other market headwinds, rates in the global reinsurance industry have been declining for some time. In response, primary players have been seen to take advantage of the buyer’s market landscape and looked to secure efficient reinsurance protection under more favourable terms & conditions (T&Cs).
Market conditions have enabled insurers, and in particular commercial players, to increasingly play the reinsurance arbitrage game, explains S&P.
“We are seeing commercial-lines insurers strive to take greater advantage of reinsurance arbitrage (profiting by exploiting pricing differences between reinsurance and direct insurance). Unlike in the late 1990s, the good news is that U.S. cedants have not changed their underwriting appetite and have not set their risk tolerances based on the availability of reinsurance. Instead, reinsurance offers cedants the opportunity to increase their gross limits while maintaining the same net limits,” said the rating agency.
In the current low interest rate environment both insurers and reinsurers are struggling to generate sufficient profit on the investment side of the balance sheet, and the resulting drive to reduce expenses and increase efficiency wherever possible, has led commercial insurers to leverage opportunities, which includes greater reinsurance arbitrage.
“Additionally, cedants are taking advantage of higher ceding commissions, which have been neutralizing the impact of higher costs in their expense ratios. We also notice reinsurers offering treaties for businesses that are traditionally written on a facultative per-risk basis, which we view as a more-efficient form of reinsurance. Furthermore, at Jan. 1 renewals, we saw one large primary writer cede horizontally multiple risks in the same treaty, signaling ambitions to protect gaps of coverage and reduce volatility risk,” continued S&P.
Competition in the global reinsurance landscape and the availability of an abundance of efficient capacity, both traditional and third-party, has enabled commercial insurance players to profit from reinsurance arbitrage. And while rate declines have decelerated in more recent times the buyer’s market remains and primary players will likely continue to make the most of favourable market conditions and efficient reinsurance capital.
Suggesting greater reinsurance arbitrage from commercial insurers players could continue and even increase in the coming months of the soft reinsurance marketplace.
“Although cedants’ reinsurance purchasing strategies differ, the common denominator is that reinsurance optimization does not translate into underwriting dilution. Although it is unlikely, we could take rating actions if we start to see insurers rely on cheaper forms of reinsurance to support excessive growth, poor underwriting standards, or insufficient risk management,” said S&P in a report.
