Although the true reinsurance appetite of third-party capital may not be as big as recent industry headlines suggest, the likely result of the actual influx, when combined with existing capital, will be smaller underwriting profits, A.M. Best says.
Best’s assessment of the whether this capital wave is actually flooding the reinsurance industry is included in a special report on the global reinsurance market published on Monday, in a section titled, “The Capital Challenge: Reinsurance Capacity Overshadows Market.” In the special report, A.M. Best also presents its outlook for reinsurer financial strength—currently stable—along with a list of the top 50 global reinsurers, and discussions of market conditions in Brazil, MENA, Asia, and the Lloyd’s market.
As for third-party capital, Best says “front-line sources indicate that capital is entering methodically and precisely, not just rushing in blindly” to the reinsurance sector, suggesting that “industry headlines may be aggrandizing” the moves of investors such as hedge funds and pension funds.
Citing broker estimates that put the additional capacity over recent years at $45 billion—or 14 percent of the current global property limit—the Best report suggests that it is pension funds, rather than hedge funds, which are having the most influence on the reinsurance market. “These [pension] funds have been quietly involved” in reinsurance for a while, taking the time to move in, understand the business and get comfortable with profit cycles.
Many hedge funds “dart in and out,” chasing market opportunities, the Best report says, noting that this is not a criticism but simply points up a difference in behavior that reinsurers are coming to understand and react to.
“The bad news is that more capacity only makes reinsurance pricing more competitive, especially when demand for cover is declining,” the report notes.
As reinsurers come to understand the nature of the capital wave, the “wave of the future” for their business models now includes managing third-party capital in addition to their own, the report says. Traditional reinsurers are now seeking to build track records of fund management in case third-party capital has staying power.
It may be that a lot of the capital exits, and that traditional reinsurance companies “emerge from this soft market in strong position by sharing the brunt of future losses with third-party capital.” If the capital sticks around, reinsurers “will jockey for position” to build and demonstrate their fund management expertise “to make sure they have a horse in that race,” the report says.
At one point, the report notes that while the capital markets have historically provided capacity out on the tail for property-catastrophe risk, investors and asset managers are now showing interest in the lower layers of catastrophe programs as well as in other specialty and casualty classes.
Referring to impact on property-cat risk, the report concludes: “Given the greater pricing pressure that abundant capacity has placed on some of the most attractive margin business, A.M. Best can only contemplate the near-term effect to be thinner underwriting profits.…There is the hope that fee income and profit share on managed capital may help close the gap.
“It is argued that while pricing is under pressure, perhaps the traditional reinsurers have commanded too much rate on line,” the report adds, noting that the new capacity, by cutting off pricing peaks, may bring greater stability to pricing “for the foreseeable future.”