In recent years reinsurers have far outperformed their counterparts in economic value creation, with a 20% return to shareholders that far overrides the insurance industry’s 13% and that of the stock market, according to McKinsey’s report on the global reinsurance market.
However, this overperformance may not be sustainable in the longer-term under current market conditions, due to it being driven partially by limited insured catastrophic events and reserve releases.
These factors and growth prospects that are viewed by investors as flat in real terms have caused valuations for reinsurance companies to lag behind those of primary insurers.
Like the primary industry, reinsurers are divulged in an oversupply in capital, McKinsey noted that this is exacerbated in P&C, compared to life “by shared-and-layered placements – especially for property risks, which can be highly syndicated and include dozens of different reinsurance companies participating in the risk-transfer transaction.
“On the one hand, this creates stability and diversification across the industry. On the other hand, this complexity – and the intermediation required to structure it – increases the ultimate cost of risk transfer for the insured.
“As a result, some primary insurance companies have been seeking to consolidate their reinsurance panels as a way to increase efficiency and gain negotiating leverage to reduce costs,” said McKinsey.
The report underscored the importance of scale and diversification for reinsurers in a market with overcapacity, stating that although not most profitable in recent years, globally diversified players maintained their margins better and enjoyed superior diversification benefits.
“Larger companies have more capacity to assume larger blocks, and capacity– coupled with strong balance sheets – also allows more risk taking, and potentially higher profitability.
“Larger companies may have greater options to optimize their own balance sheets, particularly with retrocession placements and risk transfer to capital markets,” explained McKinsey, adding that despite these benefits, scale and diversification are not the only factors contributing to a reinsurer’s success.
“Several leading reinsurance companies have reached efficient scale across the lines of business within their risk appetite. And, to state the obvious, the reinsurance industry is hardly a “winner takes it all” game, since cedents still have to diversify across several reinsurance partners to ensure stability and promote a healthy, competitive dynamic.”
