The long-term business model of the reinsurance industry is being challenged by the inability of reinsurers to command pay-back following the losses of 2017, leading to a likelihood of more sector mergers & acquisitions, according to analysts from Morgan Stanley.
Having visited Bermuda recently to meet with reinsurers, Morgan Stanley’s analyst team came away viewing the reinsurance sector as under increasing pressure and facing significant challenges.
With the January 2018 renewals having disappointed many, the analysts now forecast the mid-year 2018 renewals will be flat to up +5% at best, while they now expect January 2019 will see rates coming under further pressure.
A key reason for the pressure is the glut of capital in the sector, as traditional reinsurers have ample capacity at their disposal despite last year’s catastrophe losses, while the alternative reinsurance sector has grown strongly, following its impressive reload after the hurricanes and wildfires last year.
Morgan Stanley’s analysts expect June and July reinsurance renewals will result in “underwhelming” rate movements, with renewal pricing flat in the main and up as much as +5% where accounts were hit by losses.
The hoped for rate increases have been dampened by the supply of both traditional and alternative capital, which “challenges the long-term business model of reinsurers” and is likely to result in more sector consolidation and M&A.
Loss free accounts are expected to be renewed at the same terms as a year ago, so flat, while the loss impacted are not now expected to command the rate increases that in the past reinsurers would have hoped for.
On rates, the analysts say, “A further deceleration at June 1 renewals could challenge the long-term property cat reinsurance business model – reinsurers get payback in higher prices after large losses.”
As a result, reinsurers are expected to increasingly consider their long-term business strategy, leading to more M&A discussions, although the impending hurricane season could slow any deals from being consummated.
The analysts expect that large international insurers, such as the European and Japanese firms, could be buyers, as well as some domestic players.
The international and globally diversified re/insurers may be best positioned to soak up companies that have historically relied on property catastrophe earnings, as the diversification benefit may help them to sustain participation in that market even without the pay-back once received.
Bermudian reinsurers and U.S. specialty or regional insurers could be attractive to international players looking for a U.S.market foothold as well, the analysts explain.
Partnerships with companies outside the reinsurance sector could also be a way to sustain the lower rate environment, while shifting the business model to one more driven by data and analytics, with industry diversification benefiting capital efficiency as well.
The business model of mono-line reinsurers has been challenged for years now, while the model of those more diversified has been forced through change that is still bedding in.
In some cases this means M&A is challenging, as it is either hard to see a future for some companies that have been too focused on the softened areas of the market, or companies are in a state of flux and have yet to prove their ability to ride the cycle over the longer-term.
That means the number of M&A targets is actually quite narrow, except for those that can be targeted by major global players as a simple bolt-on acquisition.
As the challenges the reinsurance business model faces increase it makes executing M&A increasingly difficult and finding a partner even harder. Of course that could create some urgency in the market, which is likely to increase the conversations about M&A between firms significantly, even if not that many examples are actually pushed through to a deal.
