KBW remains cautious about Bermuda

25-05-2018

Midyear catastrophe reinsurance renewal rate increases are lagging January 1 increases, according to the latest briefing note from analysts Keefe, Bruyette & Woods (KBW), based on visits with numerous Bermudian insurance, reinsurance, and broker executives.

KBW said that notwithstanding mid-year's higher prevalence of loss-impacted accounts and Hurricane Irma's continuing modest loss "creep,” KBW thinks the industry's inability to materially raise rates after 2017's huge catastrophe losses shows that the old catastrophe reinsurance business model is "permanently" impaired, which (along with other factors) should drive sustained consolidation. More positively, strong run-off pricing appears to be a bright spot within reinsurance.

As a result KBW said that it remains cautious about the Bermudians in general and property catastrophe reinsurance in particular.

The KBW briefing said that most reinsurers reported that mid-year reinsurance renewal rate increases are smaller than rate increases were at the January 1 renewals. Loss-impacted accounts are renewing with rates flat to up 5 percent (more heavily loss-impacted Caribbean accounts are renewing with bigger increases) while loss-free layers' renewal rates are flat to down 5 percent. Loss-affected retrocessional rates are up 7-12 percent on a risk-adjusted basis (also below January's 15-17 percent increases), and are also flat for loss-free accounts.

According to KBW the consensus is that significant third-party capital (more a function of new funds than of unlocked collateral) still dominates the market, and – despite some speculation about whether this capital can withstand another year of significant catastrophe losses – KBW thinks that this capital is best viewed as a permanent feature of the reinsurance landscape, and that the asset class will persist even if individual investors or sums pull out of the market.

Similar to property catastrophe reinsurance, aviation rates remain challenged (one reinsurer said rates needed to double to be adequate), but energy rates are rising modestly along with increasing demand itself due at least in part to rising energy prices. Modest casualty and specialty lines reinsurance rate increases in response to poor profitability also appear to be sticking, despite concerns that fading catastrophe rate increases will push more capital toward other reinsurance lines.

KBW said that loss creep may delay ILS capital returns, but ILS here to stay: Loss estimates for Hurricane Irma have been drifting upward, in part due to rising loss adjustment expenses stemming from demand surge (2017's multiple events drove contractor day rates up to $1,000 from the more typical $400 rate), creating some uncertainty about ultimate losses that could pose a short term headwind for some ILS funds (some ILWs are triggered when PCS loss estimates exceed a particular threshold, but don’t actually pay out until PCS finalizes its estimates, which could take up to three years).

Also, Florida's characteristically litigious environment means that Hurricane Irma claims have a higher probability of ending up in court, boosting IBNR estimates to reflect both attorneys’ fees and a longer claims tail. Despite this loss creep (which is actually more typical of catastrophe losses than is Hurricane Harvey's modestly declining loss estimates), KBW said that it agrees with the widespread assessment that third-party capital provided proof of concept in 2017 and should be viewed as a permanent asset class for investors willing to accept some volatility in their alternative investments. As actual 2017 loss experience crystallizes, KBW expects some differentiation among ILS fund managers, and Irma-related loss creep could itself lead to market share shifts, but it doesn't expect any individual examples of ILS-related disruption (including creep on retro funds that could theoretically cascade down to property reinsurance and reinsurance) to affect industrywide pricing trends.

Beyond the depressed longer-term catastrophe earnings outlook itself (reinsurers' inability to raise rates after significant catastrophe losses is a significant change from the historical situation), KBW said that it thinks that disappointing rate trends point to continued consolidation within and beyond Bermuda. Just about all of the executives KBW met expect continuing consolidation, reflecting both a desire for growth and potential expense synergies - the dwindling earnings "subsidy" from previously profitable catastrophe business has exposed other lines' profitability pressures, driving (re)insurers to seek expense synergies to support margins.

Several executives suggested that deals are unlikely during hurricane season, but KBW said that abundant traditional and ILS capital could absorb near-term catastrophe exposure that could otherwise impede deals. The company agrees with the expectation that Bermuda’s next deal (many executives expect Aspen’s current corporate review to lead to a sale) will be done below the circa-150 percent book value multiples paid for VR and XL, and thinks that a cheaper deal could itself promote more M&A activity by recalibrating sellers’ expectations.

Keefe, Bruyette, Woods, KBW, analysis, Bermuda market, caution, renewals, M&A

Bermuda Re