While reinforcing a negative outlook for the global reinsurance industry, Moody’s Investors Service predicted a pullback in activity from insurance-linked securities funds in a report released early last week.
With the potential ILS pullback easing competitive pressures for traditional reinsurers, the Sept. 9 report—”Global Reinsurance Sector: Update to Negative Outlook”—also signaled less severe upcoming reinsurance price declines than Moody’s had originally forecast in a June outlook report.
In a statement about the new analysis, Kevin Lee, a Moody’s vice president and author of the report said: “Price declines will continue, albeit at a slower rate. We had initially considered a 15-20 percent drop in next year’s catastrophe prices a distinct possibility, but such a severe scenario has now become less likely.”
Moody’s, however, reiterated its negative outlook on the global reinsurance sector, citing fierce competition, overcapacity and low returns that continue to put pressure on the industry, despite some positive developments.
Outlook Change—and 1990s Here We Come
In June, Moody’s changed its outlook on the global reinsurance sector to negative from stable, noting that the current soft market has traits similar to the one that persisted in the late 1990s.
There’s one key difference, however, Lee said at the time. Reinsurance “buyers today have greater incentives to improve capital efficiency, limiting their need for reinsurance.”
“Tighter regulatory oversight and the need for better internal governance have pushed insurers to get more mileage out of their capital.”
The resulting lower demand for reinsurance just adds another layer of problems to conditions reminiscent of the 1990s soft market— an overabundance of capital, double-digit annual price declines, a substantial rise in buyers’ bargaining power, and predictions of industry consolidation, he noted in a report titled, “Global Reinsurance Outlook Turns Negative.”
As was the case in the late 1990s, reinsurers are selling multiple year contracts to hang onto business, and questions about what, if anything, could turn the market abound, Lee noted in the report.
Giving some specific examples of the actions of reinsurance buyers, Moody’s noted:
- Allianz SE has reduced annual reinsurance spend by €1.1 billion ($1.5 billion) since 2006 by consolidating reinsurance purchases across the group. The company bundled local risks onto a central balance sheet. Then buying reinsurance as a cohesive unit, Allianz was able to retain more risk—taking advantage of diversification benefits—and bundle higher volumes to increase negotiating clout with reinsurers.
- Zurich started centralizing P/C and life reinsurance purchases in the early 2000s, reducing the percentage of premiums ceded from 24 percent to 16 percent between 2002 and 2013.
- AIG reduced annual P/C reinsurance spend by $1.1 billion since 2009.
Moody’s negative outlook represents the rating agency’s view of the sector over the next 12 to 18 months.
Things could get even worse, Moody’s said in the June report.
In a segment where “nontraditional” capital from investors has pushed catastrophe reinsurance prices down to pre-Hurricane Katrina levels “without a clear floor,” another 15-20 percent drop next year would push prices below 2001 levels—before the Sept. 11 attacks, making it hard for some reinsurers to earn their cost of capital.
That would make Moody’s outlook even more pessimistic, the report said.
Revised View: Some Relief for Reinsurers
According to last week’s report, Moody’s is now less pessimistic about pricing even though its negative rating outlooks remains in place.
“Nontraditional competitors, such as ILS funds, have less scope to drive down prices given that they are on pace to report one of their least profitable years on record,” Moody’s said, giving one reason for tempering that 15-20 percent projected drop.
Some ILS investors are pulling back due to inadequate returns, Moody’s says. This means that a popular theory—suggesting that a sharp rise in interest rates is a necessary condition for exit of capital from ILS—is not entirely accurate, Moody’s notes.
Indeed, pullback is coming even though interest rate forecasts have been revised lower in recent weeks, Moody’s says.
Still, reinsurers—and analysts who assign ratings to reinsurers—have cause for concern. “Low returns on liquid ILS, for example, will prompt some investors to broaden their investment range, further infringing on traditional reinsurers and forcing them to shift capacity to other lines,” says Lee.
What about a big catastrophe loss?
In last week’s announcement, Moody’s said that the rating agency “increasingly believes that a large U.S. catastrophe event, more so than interest rates or any other factor, would test the reliability of nontraditional capital and determine its long-term penetration in the reinsurance market.”
But in the June report, Moody’s also noted that the prospect of higher prices following a large catastrophe event could attract new inflows, “taking the steam out of any hard market.”
See related article, “1990s Soft Market Redux? Not Quite, But Global Re Outlook Negative, Says Moody’s,” for more on the June outlook revision to negative.