ILS could prove game-changer as discipline finally wanes

Despite a concerted effort to hold fast against competition from the convergence sector, underwriting discipline may be waning as levels of alternative capital intensify, a report from AM Best has found.

The report suggests that the sector may be at an apex, with results likely to be on a downward trajectory following a favourable 2013.

The January and April renewals have provided some indication of the tough road ahead.

Alternative capital flows have continued to increase, primary insurers are increasing their retentions, reinsurance panels are narrowing, and excess capacity is encouraging reinsurers to fight for their positions, the report found.

Conditions are creating a perfect storm for the reinsurance sector.

As AM Best points out: “It seems ironic that as underwriting opportunities have waned, the reinsurance sector has attracted additional capital to a market already saturated with it.”

AM Best says that ILS players’ ability to operate at a “lower cost of capital is placing pressure on the traditional reinsurance model to become more capital efficient or increase investment returns by taking more asset risk.” This is causing investment risk to be added to that taken on underwriting, the report finds.

Reinsurers will have to be disciplined as they look to ride out what is likely to be a tough few years ahead.

“At this stage of the market cycle, the worst scenario would be to forego prudent enterprise risk management controls, relaxing underwriting criteria or taking an overly aggressive investment posture,” the report warns.

There may be a temptation to pursue riskier and more profitable investment strategies, but as AM Best cautions, investment returns tend to “serve as ballast during periods of volatile underwriting”. All it would take would be a cat-heavy year to compound potential problems.

Players will need to pay close attention to capital management, the report says, which “still may be the better alternative to chasing underpriced business”. Bermuda re/insurers have been particularly active in that regard and this is likely to continue.

Conditions are also likely to encourage M&A, as larger players look to put capital to work and smaller participants “feel pressure to find a safe ramp off”.

It is evident that AM Best’s long-term outlook for the sector is turning increasingly negative.