Reinsurers “found religion” on need to produce reasonable returns: JMP Securities

Indicating that they do not feel reinsurance pricing will fall-back significantly from recent highs, even when new capital flows into the market, analysts at JMP Securities stated that reinsurers have found a new religion – the need for reinsurance to produce a reasonable level of return for stakeholders.

Returns in reinsurance had been thinned out significantly through the 2010’s, with softening of property catastrophe reinsurance pricing and widening terms evantually becoming a significant issue.

That soft market environment, which was caused by factors including the build-up of reinsurance sector capital through relatively benign catastrophe loss years, competitive dynamics between traditional and alternative players, as well as a fast-growing ILS market, meant portfolios ended up unprepared for the losses they faced later in the last decade.

Ultimately, there was zero fat in the returns provided by reinsurance, to absorb some of the severe weather and natural disaster volatility that was seen.

But, with reinsurance rates having firmed up since 2017 and hardened over the last two years, the analysts at JMP Securities are hoping that reinsurers have learned from the lesson the softening of the previous decade taught, that there must be enough return in the business underwritten to enable a reasonable return to be delivered to investors, shareholders and other backers.

It’s the big question of the moment.

Will the market soften back towards previous lows, if reinsurance and insurance-linked securities (ILS) capital both grow significantly through the next few years, or will the market be disciplined and hold onto a new, higher minimum or base level of returns?

The analysts from JMP Securities say they find it hard to believe reinsurers will relinquish the new ability to generate much higher returns.

This goes for the pricing side and also the terms and conditions of reinsurance coverage now offered, the analysts believe.

However, they do believe that property catastrophe reinsurance market conditions are likely peaking right now, with no further to go on price or on terms.

On Florida specifically, “If the season runs clean, or at a low/moderate level of catastrophe losses, reinsurance ROEs should be strong, and structurally we find it difficult to envision an environment where reinsurers substantially increase pricing again next June 1,” they state.

But added that they, “Believe the contract terms (named storm, abundance of 7-month ILS covers, etc.) have been tightened to a point that it is difficult to foresee them being stripped down materially further.”

However they add that they, “Struggle to see a scenario where pricing would fall substantially.

“Reinsurers have found religion on the need to produce reasonable returns, and one good year does not make up for 5+ years of losses.”

Rates do not need to rise further for reinsurance stocks to deliver what investors want, the analysts believe.

As, “Holding serve at/near current rate levels for a period of time will result in substantial earnings and book value growth for reinsurers over the next several years.”

All of which suggests a possible period of higher reinsurance pricing, with reinsurers keen to deliver on a level of return that will satisfy their investors and stakeholders.

Which reads across positively for the ILS market, as there managers and investors are also determined to hold the baseline of rates far higher than they had dwindled to a decade ago.

While there is a chance that in a year’s time reinsurance rates for Florida do decline somewhat, if the legislative reforms can be proven to have a positive effect, even then JMP Securities analyst team believe reinsurers will still have a return-focus.

Should the Florida reforms prove effective, “This could lead to downward pressure on pricing at next year’s June 1 renewal, but not at the expense of reinsurers’ margins,” they explain.

Which is the really critical piece of the equation. As reinsurance pricing really should soften and decline if the industry is making efficiency gains, but not driven by excess capital related competition and not at the cost of sector returns on capital.

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