Investment returns are the biggest concern facing reinsurers with prospects for medium-term improvements appearing bleak, according to AM Best.
In its latest examination of the reinsurance market, the rating agency said that reinsurers are pursuing short-term fixed income investment strategies in an effort to reduce the impact of the low interest rate environment. They have also increased holdings of cash and short term investments in order to be able to deploy them quickly when the markets begin to tick upwards. The report said that management teams are preparing themselves for both inflationary and deflationary environments.
The troubled investment environment has put pressure on underwriting, while the overlay of overcapitalisation within the reinsurance space, rising levels of alternative capital and increased insurer retentions, continue to present a further challenge.
The report found that a 15 percent return on equity was no longer a risk-free option for reinsurers. With pressure likely from shareholders, the question is how far out on the risk curve reinsurers are reinsurers prepared to go, and how worrying would getting their fingers burnt on risky investments be if it occurred in the same breath as a major cat loss? With reinsurers pursuing more short-tail, higher-margin business as a result of lacklustre investment returns —which in many instances will have a cat focus—the potential of investment and underwriting risk coalescing may be ratcheted up still further.
Sidecars: in ever tighter spirals
The report found that capital market interest has resulted in a rise in the deployment of sidecars, as reinsurers look to establish themselves as third party risk managers. Such vehicles offer the potential for fee income and an add-on to the reinsurer’s balance sheet, but the report said that additional capital would serve to make the reinsurance market more competitive and questioned the sustainability of such capacity.
“The traditional market has prided itself on long-standing, deep client relationships. Should this additional source of capacity decide to quickly exit, underwriters will have some explaining to do. Reinsurers must seriously contemplate this reputational risk.”
The report said that the management of third party capital will likely fall within capital management strategies that include a likely stepping up of, M&A and share buy-backs, as well as efforts to reduce cost of capital, as reinsurers look to add value in the depressed investment and underwriting environment.
AM Best, investment returns, sidecars, alternative capital, results