In hard reinsurance markets of the past, a key feature has been an influx of capital from new entrants, but there’s been a notable lack of start-ups during the current period of reinsurance market tightening, and there are some good reasons why this time really is different, according to Brian Shea, Chairman, Global Strategic Advisory, Gallagher Re.
In a recent report authored by Shea, reinsurance broker Gallagher Re questions why there’s been a lack of new entrants in the hard market of the past 18 months, given that it’s arguably “the strongest and most synchronized market hardening the reinsurance market has seen since 2001.”
In previous periods of market dislocation, such as the liability insurance crisis in the mid-80s, in 1993 after Hurricane Andrew, 2001 after the World Trade Centre attacks, 2005 after the trio of large hurricanes, and 2020 after the global pandemic, new entrants were prominent and boosted the capital base of the sector.
But apart from a couple of material capital raises from incumbents, including Beazley and Everest, the 2023-2024 hard reinsurance market has failed to attract a slew of new market players. According to Gallagher Re, there’s four principal reasons why this hard market is different from previous ones.
“First, the current cyclical upturn has been earnings-led,” says Shea. “As set out in Gallagher Re’s Reinsurance Market Report, in the 10 years up until the end of 2022, the global reinsurance sector generally failed to generate an ROE in excess of its cost of capital.”
Shea highlights that overall, there has not been a capital shortage in the reinsurance market, meaning that, for the most part, carriers have not needed to raise capital to take advantage of favourable market conditions. The lack of a capital shortage also means that there’s simply no gap that new players could fill.
“Secondly, there has also been residual skepticism about structural profitability in the global reinsurance sector. In the run up to the 1.1.23 renewals, investors could smell a whiff of what was cooking,” continues Shea.
While this did attract interest in the reinsurance sector, Shea notes that any enthusiasm was tempered by the lack of strong performances reported by reinsurers, particularly as losses from natural catastrophes were consistently above budget for many reinsurers.
However, last year this all changed as reinsurers tightened terms and conditions, raised attachment points and moved away from frequency events and aggregate covers, which meant that primary insurers assumed a far greater share of the nat cat burden during the year, which was characterised by intense severe convective storm activity in the US.
“On the whole, 2023 was a banner year for reinsurers. As well as light Cat losses, improved pricing and T&Cs produced much healthier underlying underwriting performance, and investment returns were strong too,” says Shea.
As a result, Gallagher Re pegged the full year 2023 ROE for the global reinsurance sector at 20%, which is comfortably above its excess cost of capital.
“Such a strong 2023 has served to further strengthen the capital base of the incumbents — we calculate that the global reinsurance capital base grew 12% in 2023 to reach its highest ever level. This reinforces our point on capacity and leads us to our third,” says Shea.
The third reason highlighted by Gallagher Re concerns market duration and just how long the current upturn will last.
As highlighted by Shea, one of the ways investors can participate in the hard market without making such a commitment to duration is to invest in insurance-linked securities (ILS), such as catastrophe bonds. 2023 was a record year for cat bond issuance, and data from our ILS-focused sister site, Artemis, shows that the first half of 2024 has also broken records, highlighting just how much new capital has been flowing into the alternative capital space.
“Beyond cat bonds, we have also seen hedge funds and private equity money returning to the sidecar market, and this might be soaking away some funds that in other years would have gone into start-ups,” adds Shea.
The fourth and final reason this hard market is different, according to the reinsurance broker, is the fact the deployment of private equity capital has, in general, been slow over the past couple of years across all sectors.
Shea explains: “KPMG indicates that PE deal activity into financial services, including the (re)insurance sector, declined by 19% in 2022 and by a further 64% in 2023, measured by deal value.2 Higher interest rates, and uncertainty over funding costs generally, have been factors behind the slow-down. There may also be a concern amongst PE backers about what the exit might look like, as PE-sponsored IPOs have also slowed significantly.”
Of course, as funding costs reduce, there is scope for private equity appetite for reinsurance to increase, but the question then becomes whether reinsurance market conditions are still favourable.
“There are some good reasons why this dramatically hardening reinsurance market has not been accompanied by a slew of new entrants. With the possible exception of start-ups focused on casualty, we don’t see that changing.
“But going forward neither do reinsurance buyers need that incremental capacity, in our view. Capital strength amongst incumbents has gone from strong to stronger. And diversification of reinsurance supply has improved. Gallagher Re’s analysis, as presented in our April 1st View report, is that increased reinsurer capacity, coupled with increased appetite, should lead to an easing of reinsurance market terms and conditions,” says Shea.
Concluding: “Moreover, if reinsurance capacity allocated to casualty risks were to be withdrawn, there may be a more conducive environment for replacement capital to enter the sector.
“In the meantime, robust flows into cat bonds, sidecars and other ILS offer good opportunities to diversify capital supply. A trusted adviser, offering timely and relevant information, can help cedants flex nimbly between different sources of capital.”
