“Not a classic hard market” so rate momentum should persist (for a time)

The current firming of reinsurance is perceived as “not a classic hard market” by analysts at Peel Hunt, who after meeting with underwriters from the Lloyd’s market concluded that rate momentum should persist through 2021.

Brokers also concur with this assessment, Peel Hunt’s equity analyst team said, with their main conclusion being that “rates will maintain momentum in 2021 after accelerating in 2020.”

The analysts note that this January reinsurance renewals is the first one since the market began firming where “rates are having a compounding positive effect on underwriting margins.”

However, while the rate environment in reinsurance has been and is expected to continue to be positive for reinsurers, the analysts still aren’t convinced that their underwriting performance will dramatically improve.

Headwinds are everywhere, it seems, and the analysts cite: low interest rates; continued uncertainty over eventual losses from the COVID-19 pandemic; US casualty claims and social inflationary factors; increasingly frequent medium-sized catastrophe losses (such as California wildfires); recessionary claims; and ongoing concerns over the quality of reserves.

Together, the analysts say that these factors “could continue to erode headline profitability in the short term.”

Over the longer-term though, the analysts believe that once the market has reset its profitability, returns on equity (RoE’s) should “markedly improve.”

“Those carriers with legacy issues will lag those start-ups that have built scale in the past few years but without the legacy issues of the past,” the analysts say, echoing our earlier article stating that reinsurance startups with a clean slate may be the best place to deploy capital right now.

The Lloyd’s players that Peel Hunt’s analyst team spoke with all suggested that insurance rates are moving faster than reinsurance around the January 1st 2021 renewals.

Leading the analysts to suggest that, “The momentum in insurance still has legs and is broad based.”

Which suggests the potential for some more tailwinds for reinsurance rates going forwards as well.

While the reinsurance brokers have largely cited reinsurance rates as having risen by mid-single digits, Peel Hunt said that two of the largest syndicates and managing agents at Lloyd’s have said that their rates were up between 7% and 9%, while loss affected accounts were in the double-digits.

We’d concur that there is nothing “classic” about reinsurance markets now anyway.

While the discussion over the death of the reinsurance cycle has largely gone away, as it clearly responded to the wide range of pressures the industry has faced on profitability, we still believe this is a cycle driven by a need for profits and hope that underwriters are resetting baselines on price, to ensure future profits.

As ever, capital is the wildcard and with forecasts suggesting more capital will flow into reinsurance through 2021, the market may enter a delicate balancing-act on rates by the end of 2021, without further significant loss activity and increases in burden due to COVID.

Once an equilibrium on price is achieved, to deliver the RoE’s reinsurers require over the longer-term, it’s likely we’ll see other dynamics coming into play, particularly efficiency of operations, expense and capital.

In some quarters these important market dynamics have been forgotten, in favour of making hay while the market hardened.

But, in reinsurance, there is still a better way to do business and a significant expense and cost load placed on every dollar of risk transferred.

At some stage the focus will have to revert back to that, especially as the market increasingly features new players that are less encumbered by legacy, on the risk and operational sides.

These dynamics suggest there is nothing classic about reinsurance right now. Rather a wholesale resetting of rates is ongoing, as profitable levels of underwriting return are sought.

Which should persist, as the analysts suggest, for a time at least.

As we’ve repeatedly said, reinsurance pricing needs to cover loss costs, cost-of-capital, expenses and a margin. If the current momentum persists long-enough, it will eventually reach a point where capital/efficiency etc tip the rate momentum once again.

Leaving reinsurance poised for a fascinating few years, as the same old dynamics of capital, costs, efficiency and structure return to the forefront, alongside potential new ones that may get an increasing focus as well, service provision and responsiveness to client needs.