Pricing momentum may extend beyond 2021: Morgan Stanley

Analysts at Morgan Stanley said that pricing momentum across insurance and reinsurance may extend beyond 2021, as a return to profitability remains a priority for reinsurers, while insurance-linked securities (ILS) specialists focus on delivering sustainable returns to investors.

Rate momentum in reinsurance is expected to continue catching up with primary insurance and retrocession, as the improvements in reinsurance pricing seen so far are still lagging behind, the analysts believe.

January 2021 renewals are key, as the reinsurance market seeks out more sustainable levels of pricing that support its cost-of-capital over the longer-term.

With so many areas of the market set to renew in January where rates have not risen for a decade or more, European property catastrophe reinsurance for example, how serious reinsurers are about returning to sustainable levels of return for their shareholders is set to be tested.

Having discussed market conditions with companies in the sector over the last week or two, the analysts from Morgan Stanley say that “companies are left with no option but to raise prices” as their returns have been suppressed for so many years now.

“Loss trends seem to be the key driver,” the analysts explained. But in addition, “Low for longer rates are expected to exercise additional pressure on investment income and, in turn, to support pricing improvements.”

Interestingly, despite the unprecedented nature of the COVID-19 pandemic and the uncertainty related to its impacts on the insurance and reinsurance market, this is seen as “a secondary driver as it adds to a number of uncertainties already looming on the sector.”

This is also driving re/insurers towards short-tailed lines it seems, as “On this basis, some insurers (in contrast to others) seem to recognize that risk-adjusted improvements in short tail lines are more attractive than in longer tail ones,” the analysts explained.

This is positive for reinsurance and insurance-linked securities (ILS) and perhaps there is an element of fear growing over certain longer-tailed areas of the marketplace at this time.

COVID-19 has generated increasing risk aversion, which alongside uncertainty over casualty losses and reserves, plus the influence of social inflationary factors, may promote a greater desire for rate increases across shorter-tailed lines, as the industry realises it needs returns from those segments of the market to help it cover its cost-of-capital more sustainably.

The analysts from Morgan Stanley explain that the rate improvements seen may not boost margins, as that is dependent on loss trends. But they may help to drive a return to profitability more broadly across the industry.

“While the overall sentiment has now turned positive with companies suggesting that the market is increasingly becoming a seller’s market, it remains to be seen whether companies will be able to improve overall levels of profitability. However, we understand that incumbents might continue to support rate raises until the cost of equity is covered. In the meantime we expect earnings quality to continue to improve and the sector to re-rate accordingly,” they explained.

This suggests we could see broader firming in January than perhaps expected and that rate improvements are going to be sought out again in April and the June/July renewals in 2021 as well.

Reinsurers remain well-capitalised and able to take advantage of the higher rates seen so far, but they do need to secure rate across a wide-range of classes of business in order to put themselves in a stronger position going forwards.

With the ILS market still dented by prior year catastrophes and trapped capital, now seems the right time for the market as a whole to look to establish a new, more sustainable pricing floor, that closely reflects loss costs, costs-of-capital and their relative efficiencies.