According to Morgan Stanley analysts, a 100bps increase in reinvestment yield drives a Return On Equity (ROE) increase of 5% for reinsurers, meaning global players could see wins on ROE over the next two years with an overall 1-2% premium increase forecast due to broad-based reinsurance rate increases.
“For every 100bps increase in the reinvestment yield we estimate an increase in ROE of 5% for the reinsurers, but this is higher for the Lloyd’s names (Hiscox and Lancashire) at 11.8% and 7% respectively, due to shorter asset duration,” said Morgan Stanley.
However, changes in interest rates are likely to impact the supply of alternative capital in the reinsurance space. Analysts explained that alternative reinsurance capital has flowed into the market as investors look for yield in the low interest rate environment.
If interest rates go up, catastrophe bonds, a sub-sector of the alternative capital space, could become less attractive and the capital markets investors may look elsewhere for higher returns.
Morgan Stanley believes it’s unlikely that rates would rise significantly, however, as they rise a greater proportion of earnings a cat bond investor makes would come from correlated assets since the collateral of a cat bond may be held in treasuries.
This would reduce the benefits of the investment at the margin, giving alternative capital a further reason to reduce reinsurance market portfolios.
Overall, Morgan Stanley said reinsurers will see more limited headwinds from investment income pressure in the insurance sector due to shorter asset duration.
The average yield for reinsurers is relatively low at 2.8%, and this is forecast to remain broadly stable.
However, new yields are seeing continued headwinds, especially for the life insurers such as AXA life at 3.1% and Allianz life at 3.2%, who have elevated returns, according to the report.
Morgan Stanley warned that “the continued earnings drag from unchanged reinvestment yields is not widely reflected in market views. We assume unchanged reinvestment yields in our forecasts for the reinsurers and hence could see upside in the case of rising yields.
“Amongst the reinsurers we believe that Hannover Re is most sensitive to changes in reinvestment yields due to its relatively high investment leverage and short asset duration.”
