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BESTS BRIEFING

Global Reinsurance

Our Insight, Your Advantage.

January 12, 2015

Cycle
management
is shrinking cat
portfolios.

Global Reinsurers: Who


Will Gain Despite All the Pain?
The global reinsurance sector remains by all accounts overcapitalized. The reinsurance
market has proved for some time to be a bit more resilient and disciplined than other sectors;
however, as most companies continue to indicate that intense competition is leading to lower
underwriting margins for certain lines of business, the need for disciplined underwriting
now more than ever should remain the focus. The market is expected to remain challenging
in 2015, with rates continuing to decline for some lines of business, terms and conditions
becoming even broader, and ceding commissions increasing further.
In response to these pressures, companies that are managing the cycle continue to reduce
their retained exposure to classes of business that do not meet acceptable return hurdles, and
they are expanding in classes that offer better opportunities. In 2014 this led to significant
reductions in reinsurance books of business, particularly for property catastrophe. For the
most part, 2015 is expected to produce an even more careful approach to risk selection. The
orderly approach to risk selection appears to be working for global companies, and most are
expected to remain cautious on the business they write as capacity remains high and the
market becomes increasingly competitive.
Companies with both insurance and reinsurance books of business continue to be more
weighted toward primary business, given that pricing remains relatively more attractive
and access to the business easier. That said, some primary lines have started to show some
negative pricing or a slowdown in price increases over the past few quarters. Conversely,
companies that write predominantly reinsurance and focus on underwriting are in danger of
reducing their books of businesses to levels that may render them less relevant in the market,
which could lead to more merger and acquisition activity.

Analytical Contacts

Mariza Costa Oldwick


+1 (908) 439-2200 Ext. 5308
Mariza.Costa@ambest.com
Greg Reisner, Oldwick
+1 (908) 439-2200 Ext. 5224
Greg.Reisner@ambest.com

Editorial Management
Brendan Noonan

The cultural barriers that have been cited in the past as obstacles to consolidation may
become less of a factor if companies shrink to where they can no longer compete in this
increasingly global market. This past year, Validus Re acquired Western World in the
United States. In November, Renaissance Re announced that it would acquire Platinum
Underwriters, and in mid-December there was speculation that Montpelier Res board was
considering putting the company up for sale. In January 2015 XL entered a definite merger
agreement to acquire Catlin. All of these are examples of the need for greater global scale
and diversified product lines and distribution, replacing the days of specialty focused
reinsurance companies. Companies with well-diversified businesses and a global reach
likely will only get larger as smaller players put themselves up for sale or seek strategic
partnerships to survive.

Pricing Still Under Pressure, New Capital Remains


Pricing in 2014 experienced double-digit declines in certain lines of business, and reinsurance
pricing overall is expected to remain under pressure in 2015, given the lack of any pricechanging event over the past few years. During 2014, reinsurance companies have seen
property cat price declines of 20% in some cases (more pronounced in the United States)
for all renewal seasons. The dramatic price declines in 2014 continue to be attributed to the
lack of market-changing losses, as well as increased retentions by ceding companies and the
persistent inflow of capital from the capital markets, largely in the form of insurance-linked

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Briefing

Global Reinsurance
securities (ILS). January renewal pricing for property contracts was once again down 10%15% for both U.S. and European risk. U.S. casualty was up 5% to down 20%, depending on loss
experience, and in Europe casualty rates were up 5% to down 10%, also depending on loss
experience. Aerospace was flat to down 7.5%, and global trade credit was down 10%-20%.
Concessions in contract terms and conditions, including greater ceding commissions and
multiyear contracts, continued for the Jan. 1, 2015 renewal season.

Third-party capital is expected to continue


entering the market in upcoming years
as large pension funds and hedge funds
seek ways to diversify their portfolios
10,000
while chasing higher returns. In 2014, 43
cat bonds were issued, totaling USD 8.8
8,000
billion (see Exhibit 1) and representing
6,000
15% growth from 2013. This made 2014
a new record year for cat bond issues,
4,000
with 44% of the bonds increasing in size
2,000
before the deals closed, which implies a
continuing appetite for the issued risks.
0
With new capital and reduced reinsurance
Exhibit 1
purchasing by some large cedents,
Global
Reinsurance
Source: A.M.
Best data & research,Artemis, company reports
market conditions are expected to remain
Cat Bond Issues by Year
challenging for the reinsurance business
10,000
Exhibit 2 in 2015 and lead to further pressure on pricing, particularly in property and cat lines. The
intensified
U.S.8,000
& Bermuda
competition in property reinsurance and cat continues to spill over to other lines
of reinsurance
geographies
Reinsurance
CombinedandRatio
Trend as companies attempt to expand their product offerings and
6,000
presence.
This,
in turn,
puts still
more upward pressure on ceding commissions for
Loss Ratio global
Expense
Ratio
Favorable
Loss Reserve
Development
quota-share placements and is leading to more multiyear contracts, broader contract terms
1204,000
107.3 signings on aggregate covers.
and increased
2,000
93.1
USD Millions

1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014

USD Millions

Exhibit 1
Global Reinsurance
Cat Bond Issues by Year

100

92.7

30.0

86.8

87.4

Lack of Cats and Reserve Releases Continue to Aid Profitability

29.8
30.4
30.9
31.5
29.7 Given the lack of major cat
losses 31.7
and ongoing favorable reserve development, most reinsurers

60
Source:
A.M. Best
data & research,
Artemis,
company
reports
continue
to deliver
solid
combined
40

93.2

1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014

80

85.8
0

77.3

ratios.

63.4
61.8
56.12
55.7
55.3
Exhibit
20
U.S. & Bermuda
0
Reinsurance
Combined
Ratio
Trend
2009
2010
2011
2012
2013 2014 Q3

62.8

5-Yr Avg
Loss Ratio
Expense Ratio
Favorable Loss Reserve
YTDDevelopment
120 A.M. Best data & research, Imetrix, Bloomberg, company reports
Source:
107.3
93.1
100
92.7
93.2
87.4
30.0
85.8
86.8
Exhibit 3
80
29.8
30.4
30.9
U.S. &29.7
Bermuda
Reinsurance
Return31.7
on Equity
31.5
18
60
16.2
Return on Equity
5-Yr Avg
16
40
77.3
14
63.4
62.8
61.8
12.4
56.1
55.7
55.3
11.9
12
20
10.9
10.6
10
0
8 2009
2010
2011
2012
2013 2014 Q3 5-Yr Avg
YTD
6

Over the past five years, the average


combined ratio for the U.S. and Bermuda
reinsurance composite is about 93.2 (see
Exhibit 2), and that number reflects the
significant losses in 2011 that included
the Japan and New Zealand earthquakes,
Australia floods, U.S. tornadoes and Thai
floods. In 2011 these companies reported
an average combined ratio of 107.3 due to
all of these events, making that year among
the toughest in recent memory. That said,
all these events did very little to change the
trajectory of pricing, as available capital in
the market remained abundant.

Source: A.M. Best data & research, Imetrix, Bloomberg, company reports

4
2

1.0

Exhibit
3
0
2010
2011
2012
2013
2014 Q3
U.S. &2009
Bermuda
Reinsurance
Return
on Equity
YTD

Source:
18 A.M. Best data & research, Imetrix, Bloomberg, company reports

Favorable reserve releases and the lack of any


major cats over the past few years continue
to aid combined ratios for the entire industry.

30.0

85.8

80

Briefing

29.7

29.8

30.9

86.8

87.4

31.5

31.7

60

30.4

Global Reinsurance

40
56.1

61.8

77.3

63.4

62.8

55.7

55.3

Over the past five years, favorable reserve releases 20


have reduced combined ratios by an average
of 6.1 points per year. Only time will tell how commissions, lower premiums and possible
0
diminishing reserve releases play out and what companies
as the2013
market
2009maintain
2010 profitability
2011
2012
2014 Q3 5-Yr Avg
YTD
becomes more challenging.
Source: A.M. Best data & research, Imetrix, Bloomberg, company reports

Strong ROEs, but for How Much Longer?

Exhibit 3
U.S. & Bermuda Reinsurance Return on Equity
18
16

16.2

14

Return on Equity

5-Yr Avg
12.4

11.9

12
%

Although pricing continues to soften,


and terms and conditions are becoming
more challenging, the U.S. and Bermuda
reinsurance sector is still delivering solid
returns on equity (ROEs). For the past five
years, the average ROE for the sector is about
10.4% (see Exhibit 3), and that includes
the significant losses of the 2011 events that
led to negative results for many. Favorable
reserve releases and low cats which have
produced solid margins and efficient asset
management continue to drive the strong
ROEs, but as the industrys struggles persist,
ROEs are expected eventually to settle into
single-digit territory for some time, for most
if not all companies.

10.9

10.6

10
8
6
4
2
0

1.0
2009

2010

2011

2012

2013

2014 Q3
YTD

Source: A.M. Best data & research, Imetrix, Bloomberg, company reports

As premiums continue to decline, investment returns remain low, reserve releases taper, and
Exhibit
4
commissions increase, it is expected to be increasingly
challenging
to deliver double-digit
Global
Reinsurance
buybacks also are
ROEs. That said, given the strong capital positions of many companies, share
Estimated
Total
Dedicated
Capacity
expected to remain a strategy for companies looking to improve returns for shareholders,
and
450
that will slightly offset some of the challenges companies
face on the income side.

USD Billions

400
350 if capital continues to enter the market
Returns are expected to become even more challenging
300
at such a high rate, reserve releases decline, and pricing continues to soften in the double
250
digits. The scenario for lower ROEs and an uptick in 200
combined ratios as commission expenses
increase further and premiums continue to decline 150
is possible in 2015, particularly if pricing
declines spill over the primary side of the business at100
a faster rate throughout the year.
50
0
Overall, this remains a challenging market, but the reinsurance
composite is expected
2012
2013 to post

solid results for 2014, which was aided by the lack *ofEstimate
large by
catGuy
losses,
ongoing share repurchases
Carpenter
Source: A.M. Best data & research, Guy Carpenter
and favorable reserve releases. Conditions will remain competitive and challenging, as primary
companies are expected to continue retaining more business and/or seeking higher ceding
commissions or multiyear contracts for sharing their profitable business. Margin compression
also will likely persist as third-party capital seeks a larger piece of the pie. As a result, A.M. Best is
forecasting underwriting performance for the United States and Bermuda to produce an average
combined ratio of 94.8 and an average ROE of 8.2% for 2015, representing a stubbornly difficult
market environment and a normal level of catastrophe activity.

Dedicated Global Reinsurance Capacity


Dedicated reinsurance capital is shown in Exhibit 4. This is the second year A.M. Best has
compiled an estimate of dedicated global reinsurance capacity, working in conjunction with
Guy Carpenter. This estimate is not a simple aggregation of the shareholders equity of all
companies that write reinsurance, since some of that capacity is allocated to the insurance
business or other outside interests. A.M. Best and Guy Carpenter have estimated the amount
of capital dedicated to writing reinsurance by using A.M. Bests proprietary capital model,

2014E*

2009

2010

2011

2012

2013

2014 Q3
YTD

Source: A.M. Best data & research, Imetrix, Bloomberg, company reports

Briefing

Global Reinsurance

USD Billions

Exhibit 4
Global Reinsurance
Estimated Total Dedicated Capacity

Bests Capital Adequacy Ratio (BCAR),


and reviewing line-of-business allocations
for the majority of the top 50 reinsurance
organizations, while giving consideration
to reinsurance capacity offered by smaller
participants in the market.

450
400
350
300
250
200
150
100
50
0

At year-end 2013 there was approximately


USD 320 billion of traditional capital and
USD 48 billion of convergence capital,
including industry loss warranties,
collateralized reinsurance and cat bonds.
2012
2013
2014E*
On this basis, A.M. Best estimated marginal
* Estimate by Guy Carpenter
growth in traditional sector capital as strong
Source: A.M. Best data & research, Guy Carpenter
earnings again sustained share buybacks
and dividends, and reinsurers sought to maintain but not expand their capital positions.
As previously noted, convergence capital continued to pour into the industry. Cat bond
issuance (shown in Exhibit 1) continued to grow strongly. Likewise, capital continued to
flow into collateralized reinsurance vehicles and sidecars. Guy Carpenters current estimate of
convergence capital, including cat bonds, is USD 60 billion for 2014, up USD 12 billion from
the prior year.

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SR-2015-B-591