Renewed enthusiasm for reinsurance
While the mood of reinsurers in Bermuda may be chilled by the prospect of further price erosion at January 1, 2011, insurers are increasingly looking again at the value that reinsurance can add to their capital management and product innovation initiatives.
The outlook for US property catastrophe treaty renewals at January 1, 2011 (see Exhibit 1 below) reflects further softening from January 1, 2010. The rate of softening, however, will decrease as reinsurers begin to reach return profiles that are now very sensitive to further price erosion.
The driver of the softening is clearly the rate of capital growth in reinsurer balance sheets. The 10 percent growth rate of reinsurers’ capital reported for the first half of 2010 greatly exceeds the growth rate of insurer demand for reinsurance.
"There is an opportunity for reinsurers to reconnect with insurers to profitably address the volatility associated with lower insurer underwriting year earnings."
Reinsurers’ capital grew in the first half of 2010 despite significant reinsured losses from a very large earthquake in Chile and a few other locally notable events. This capital resilience in the face of these losses has been noted and appreciated by insurers, many of whom had ceded material earnings volatility to reinsurers in the first half of 2010. These reinsured losses are a good reminder to insurers of the value proposition of reinsurance—reinsurance lowers insurer earnings and capital volatility.
Insurer earnings volatility remains an issue. Missing from the discussion of insurers’ lower than average stock valuations for much of this year, is the honest admission that insurer earnings are really volatile in comparison to the S&P 100 companies’ underlying earnings, for example.
Insurer returns on equity too are lower than those of the S&P 100 companies. For most of the past decade, and it is still true now, insurer returns on equity have been lower than S&P 100 company returns by one-third. What is worse from an investor’s perspective is that the volatility of insurers’ lower returns is four to five times greater than that of the S&P 100 companies.
In the last five years, there has been a growing disconnect between insurers’ and reinsurers’ views of the profitability of the underlying commercial insurance business. From reported results to date, insurers’ views of their business have proven correct and their decisions to keep more risk net has been a wise decision. The cycle, however, is now at a very different place than it was then and managing prospective volatility is much more critical than it was in the recent past.
Given the current reinsurance capital position, combined with insurers’ general agreement that today’s lower premium levels are inherently riskier, there is an opportunity for reinsurers to reconnect with insurers to profitably address the volatility associated with lower insurer underwriting year earnings, while providing an accretive source of underwriting capital for insurers that will consider significant share repurchases in 2011.
Insurers and reinsurers will also have the chance to rekindle their partnership in insurance product innovation. With industry-wide nonlife premiums set to decline for the third year in a row in three of the world’s more significant economies during 2011, innovation around the original insurance product is likely to be on the list of many leading insurers. It is hard to argue that the continuing on-level rate decrease trend is not indicative of a value proposition decline of insurance to businesses and consumers.
Recent successes of fully or partially reinsured endorsements to existing products, as well reinsurance-supported new product creation, prove that these partnerships are worth the investment of time and effort. Product differentiation still works for insurers that want to protect and grow portfolios in a competitive market, and reinsurers have the talent, time and capital to help insurers think more expansively.
Reinsurance will add further value to insurers in 2011 by providing an even more accretive source of underwriting capital than in the past and will reduce insurer earnings volatility.
In 2011, the partnership relationship of insurers and reinsurers will be back to the fore as they begin the innovation process that will be necessary to retake a positive underwriting earnings trend for both insurers and reinsurers.
Bryon Ehrhart is chief strategy officer at Aon Benfield. He can be contacted at: bryon.g.ehrhart@arw.aon.com
