A traditional soft market is coming, as alternative capital-driven pricing pressure in the reinsurance market flows to the primary market, a recent Nomura report contends.
Nomura analysts Clifford Gallant and Mathew Rohrmann say in the report—titled “The Evolution of Reinsurance: Soft Market to Spur M&A”—that one impact of the growing alternative-capital presence will be further price weakening in property/catastrophe reinsurance rates, followed by weakening across all reinsurance lines, before finally affecting primary-commercial rates.
“We have already seen a slowdown in primary-commercial rate increases despite the ongoing pressure of a low-investment-yield environment,” states the report. “Much as we have seen in generations of previous cycles, we expect that the availability of cheap reinsurance will exacerbate the fight for market shares at the primary level, leading to a traditional soft market.”
Nomura then expects consolidation as the traditional reinsurance business model comes under pressure. “Many [reinsurers] may need to merge to survive,” Nomura says. “Eventually, companies that we may not yet think of as buy/sell candidates will take part. The pressures of a bad soft market cannot be understated, in our view.”
The report ties this outlook to Endurance Specialty Holdings’ attempt to buy Aspen Insurance Holdings, stating the attempt “makes perfect sense, by our view of the world. Endurance is small and, in our opinion, could end up on the selling side to survive unless it acts quickly to grow and diversify.”
According the report, the reinsurance market is not just under pricing pressure, but is experiencing an evolution in the marketplace. “In the evolutionary process,” says the report, “things happen slowly before they happen very fast.”
Nomura notes the first catastrophe bonds were issued in the mid-1990s, but only recently has the alternative market shaken up the industry. “Much like what happened in the 1990s to the publicly traded U.S. domiciled reinsurers (none is left), we expect that a more efficient business model will force change in the reinsurance industry,” states the report.
The advantages for buyers are clear, according to the report. “As a risk-management product, cat bonds are less expensive than traditional capacity and are fully collateralized,” says the report.
Alternative capital is currently pressuring property/catastrophe rates the most, with rates already down double-digit percentages since 2012 “in what appears to be a traditional soft-market free fall,” says Nomura.
But it is quickly spreading to other lines, the report notes. “The establishment of Watford Re, by highly respected Arch Capital, will be a major alternative underwriter of casualty risks.” Nomura expects to see more players form similar vehicles, possibly eyeing liability lines such as auto or workers’ compensation as “potentially stable sources of assets” for asset managers.
Potential “wild cards” that could change Nomura’s outlook include a major loss event, which “would open up questions of reserve and balance-sheet quality and could derail activity,” Nomura says. Asked if investors who are bringing all of this capital into the reinsurance market will stick around should a major loss event occur, Gallant tells PC360 that is the big question. "I think, yes," he says. "They seem to be sophisticated investors, aware of the risks they are taking."
Nomura also cited rising investment yields and “entrenched management” that resists acquisition as potential wild cards.