According to Fitch Ratings, the challenges faced by traditional reinsurance firms are likely to “extend beyond a normal soft market cycle” as factors such as the growth of alternative capital, changes to the value-chain and higher regulatory costs all weigh on reinsurers.
Reinsurance prices are expected to fall by up to 10% during 2016 (Moody’s) and Fitch warns that prices have not yet found their floor. The reinsurance industry has come under extreme price pressure recently due to high competition; an excess supply with little demand;the benign claims environment from natural catastrophes, and the growth of alternative capital (including investment linked securities (ILS) such as catastrophe bonds).
Alternative capital could be seen as a key competitor to traditional reinsurance: by purchasing catastrophe bonds, an insurer transfers risk to the capital markets instead of transferring the risk to a reinsurer through a more traditional catastrophe cover. Since the pricing of catastrophe bonds is relatively low, reinsurance is becoming less attractive to insurers. Alternative capital will likely increase pricing competition further in the future. It is after the next major catastrophe events that this may become most evident, when the traditional players find they cannot ramp prices in the wake of losses as much as they would have liked to, due to inflows of alternative capital.
Current pricing levels are only just exceeding most reinsurers cost-of-capital and as the softened cycle persists, the risks which reinsurers struggle to manage change are set to increase. The current reinsurance market is one in which new business models for insurers are emerging which seek to extract more of the value from the premiums underwritten, rather than passing them onto reinsurers. Reinsurers are becoming increasingly aware of the need for efficiency and low costs of capital, while using technology to adapt to the changing market. The market may be shocked by how quickly conditions become radically different over the coming years and only those who are willing to embrace and manage change will thrive.