The latest A.M Best review of the U.S. property/casualty industry has highlighted how reinsurers are responding to disruptive innovation by shifting strategies to look for opportunities to benefit from, and collaborate with the influx of alternative capital into the market.
Part of what has pressured this market so significantly is the growth in convergence capacity and its concentration toward U.S. property catastrophe risk. Third-party capital continues to enter the reinsurance market in search of a non-correlating asset class to a broadly diversified investment portfolio.
A.M. Best said reinsurance companies have for several years been trying to right-size their capital base, largely via share repurchases, as well as manage the cycle by adjusting their business mix.
However,this plays into the key paradox of the insurance industry, which drives market cycles, A.M. Best explained “the more profitable a line becomes, the more capital it attracts, causing prices and underwriting standards to deteriorate and driving down profitability.
“At this point, it does not appear that the lack of underwriting profit in the current book or continued erosion in ROE will break the cycle, so long as property catastrophe reinsurance exposure is a portfolio niche for investors who are more interested in reinsurance as a non-correlated investment.”
Although insurance-linked securities (ILS) funds (the collateralized market) remain the largest and fastest- growing recipient of third-party capital, the rating agency noted that even these funds are finding it increasingly difficult to find attractive opportunities, as pricing dynamics deteriorate further and further.
In response to these challenges, the rating agency said, some re/insurers are shifting their strategy to building a fee income stream by directly managing third-party capital – an area where the reinsurance companies could have an advantage as they have the most expertise and understand the nuances of underwriting risk.
For other players, entering underwriting arrangements or fronting agreements to generate fees has increasingly become an option.
“Although entailing more work, control over the entire spectrum may be the preferred approach for a variety of reasons, including optimising profit, controlling the messaging with both the capital provider and client, and, most importantly, being in a better position to ex capital as events unfold and markets turn,” said A.M. Best.
Analysing broader macro trends and common themes across markets, A.M. Best said as industry players look for ways to lower costs and innovate to drive growth, it appears one of the industry’s main competitors, third-party capital, could also bring meaningful opportunities over the intermediate and long term, and this “may become easier because the market can allocate a growing pie as new risks and opportunities emerge—think economic losses versus insured losses from a catastrophe.”
