‘Permanently’ impaired reinsurance model drives consolidation

The inability of the reinsurance sector to materially raise rates after 2017's major catastrophe losses shows that the traditional catastrophe reinsurance business model is "permanently" impaired, which, along with other factors, should drive sustained consolidation, according to KBW analysts.

Mid-year catastrophe reinsurance renewal rate increases are lagging January 1 hikes, KBW analysts concluded after a number of investor visits with Bermudian insurers, reinsurers and brokers.

Reinsurers' inability to raise rates after major catastrophe losses is a significant change from the historical situation, KBW analysts noted.

Beyond the depressed longer-term catastrophe earnings outlook itself, the analysts think disappointing rate trends point to continued consolidation within and beyond Bermuda.

Just about all of the executives the analysts met expect continuing consolidation, reflecting both a desire for growth and potential expense synergies, as the dwindling earnings "subsidy" from previously profitable catastrophe business has exposed other lines' profitability pressures, driving re/insurers to seek expense synergies to support margins.

Several executives suggested that deals are unlikely during hurricane season (June 1-November 30), but KBW analysts believe that abundant traditional and insurance-linked securities (ILS) capital could absorb near-term catastrophe exposure that could otherwise impede deals. The analysts agree with market expectations that Bermuda’s next deal will be done below the circa-150 percent book value multiples paid for Validus and XL Group and believe that a “cheaper” deal could itself promote more M&A activity by recalibrating sellers’ expectations. Many executives expect Aspen’s current corporate review to lead to a sale.

KBW analysts believe that third-party capital’s likely permanent pressure on catastrophe margins favours property catastrophe reinsurance as one business line within a large re/insurer’s product portfolio over its being a company’s dominant business line.

The analysts pointed to Renaissance Re’s acquisition of Platinum Underwriters Holdings’s diversified casualty and specialty book and Everest Re’s insurance segment’s organic growth. Investors could become more pessimistic about catastrophe-heavy reinsurers if the next few years include “normalized” catastrophe losses (as opposed to the below-normal experience through 2016) and mostly flat catastrophe rates, the analysts warn.

KBW analysts remain cautious about the Bermudians in general, most of which benefited from benign North American hurricane seasons between 2006 and 2016, and property catastrophe reinsurance in particular.

Instead, they point investors toward Arch Capital Group, ARGO, and Third Point Reinsurance, which are all underweight in catastrophe risk.

At the same time, strong run-off pricing appears to be a bright spot within reinsurance, the analysts noted.

Pricing for run-off insurance products, including adverse development covers and loss portfolio transfers, was described by market participants as “the hardest” in almost 20 years, driven by what one run-off executive called the largest run-off pipeline he's ever seen. KBW analysts believe that this reflects the past few years’ compounded underwriting margin pressure.

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