The unhealthy path of reinsurance as described by Willis Re’s Vickers

The soft market is clearly taking its toll.

The aggregate net income of reinsurers included in the Willis Reinsurance Index tracking major international reinsurers dropped to $26.6 billion in 2016 from $30.3 billion a year ago, according to the most recent Reinsurance Market Report by Willis Re.

The reported combined ratio for the Index deteriorated to 94.4 percent compared to 91.4 percent over the period.

The reinsurance sector’s reported combined ratios have worsened despite being propped up with prior-year reserve releases and benefitting from below-average large claims.

The return on equity (ROE) dropped to 8.9 percent in 2016 from 9.3 percent in 2015.

The situation appears even worse when looking at a subset of reinsurers which make more detailed disclosures and which reflect around 58 percent of the aggregate capital index.

The reported ROE of the reinsurers included in the subset, all publicly listed companies, fell to 8.2 percent in 2016 from 11.3 percent in 2014. But after normalising the numbers for an estimated average 4 percent cat loss and adjusting for prior year development, the ROE for the subset drops to 3.3 percent for 2016 compared to 5.6 percent in 2014.

“The reality is that behind the figures that have been reported there are barely sustainable underlying results,” Vickers said at an April 20 Lloyd’s event.

In addition to the soft market, costs are increasingly weighing on results. The impact of the expense ratio on the reported ROE in the subset has grown to 2.5 percent in 2016 compared to 1.7 percent in 2014.

“The impact of the expense ratio on the ROE is really beginning to grow,” Vickers notes.

There is a disconnect between the way of how the companies have to account and report to their shareholders and the reality of what management is seeing in the underlying numbers, he suggests.

But reinsurers are taking action to improve their operating performance.

“We are seeing expense control management, we are seeing M&A,” he says. “But it’s a very tight spot for most reinsurers. Control costs, try to manage capital more actively at the best of their ability whilst retaining the confidence of their clients.”

Some of the added costs are driven through regulation such as Solvency II, Vickers adds. But he also notes that technology may help reinsurers to address the cost issue.

A number of insurtech start-ups are targeting parts of the insurance value chain, automating processes, increasing efficiency and potentially reducing costs.

One technology that has been seen as a potential game changer is blockchain, which allows for the recording of data—transactions, contracts, agreements—in a way that means the data are simultaneously stored, but also updated in real time—on hundreds or even thousands of computers globally.

The blockchain insurance industry initiative B3i has gained 15 members since its launch in October 2016, including SCOR, Hannover Re, Swiss Re and Munich Re.

Reinsurers are also actively looking for new markets which could offer better margins.

Due to continued weak pricing, reinsurers are broadening their underwriting platforms in order to deploy capital to classes of business which they view as being more favourably rated, according to the Willis Re report. Also, reinsurers are moderating their exposure to catastrophe linked business and increasing capital allocation to other classes of business which include primary, life and health and certain specialty lines of business such as agriculture and mortgage insurance.

Nevertheless, reinsurers are also returning capital to shareholders as profitable business is scarce and they try to avoid underwriting unprofitable business.

The reinsurers included in the Willis Re Index returned $16.4 billion of capital to shareholders through share buybacks and dividends in 2016. The higher equivalent 2015 value of $23.3 billion is skewed due to a reduction in dividends upstreamed by National Indemnity from $8.2 billion in 2015 to $2.5 billion in 2016.

“We are seeing share buyback authorisations increasing,” Vickers said.

Management will need to be creative to steer reinsurers through the soft market.

“It is a combination of having to pull a number of different levers to try to eke out the numbers to the best of their ability,” Vickers said.

The efforts will be needed also because rates are likely to remain under pressure. The April renewals have again seen price reductions similar to the January renewals and the June renewals are likely to resemble the previous ones, Vickers suggests.

“Why would it change? […] Buyers will automatically expect at minimum the same treatment as people received buying at 1.1. and 1.4.,” he notes.

There is limited scope for rate increases as excess capacity in the reinsurance sector continues to grow. Aggregate shareholders’ funds increased 4.4 percent to $344.1 billion in 2016, driven by net income and unrealised investment gains. Including capital from alternative markets the figure is approximately $449 billion, up from $427 billion in 2015.

“Alternative capital remains very attracted to the marketplace,” Vickers says.

“The long-term pension funds are “still quite happy” with the types of returns.”

A recent survey of 100 institutional asset allocators carried out by independent publisher Clear Path Analysis has found that more than one in five pension plans are considering new investment into insurance-linked securities (ILS) in 2017.

“There is an awful lot of capital out there that would like to become involved,” Vickers said.