Capital grows despite tough conditions

The industry’s capital continues to grow despite pressure on profits, says Mike Van Slooten, as he unveils the findings of the latest Aon Benfield Aggregate report to Monte Carlo Today.

Profitable growth is increasingly hard to achieve, catastrophe losses are up and investment returns remain subdued. Despite being faced with such challenging market conditions, overall market capital increased during the first half of the year.

Those are the main conclusions of the Aon Benfield Aggregate (ABA), a bi-annual report by the broker examining the individual and combined results of the largest reinsurers globally, thereby acting as a proxy for the global market as a whole. The study, an analysis of the performance of the world’s largest reinsurers in the first half of 2016, reveals few signs of industry pressures abating.

“It remains a tough environment,” says Mike Van Slooten, head of the international market analysis team at Aon Benfield.

The weakening global economic outlook is making life difficult for reinsurers. The ABA report highlights that those companies that have managed to achieve growth have generally done so inorganically, through mergers and/or acquisitions. “But some have achieved growth by building out their insurance franchises. There are very few pure reinsurers left,” he says.

He also notes that many reinsurers have been taking advantage of lower cost retrocessional capacity to control their modelled probable maximum losses within expected tolerances.

According to the report, the aggregate pre-tax profit for the ABA group was $11.5 billion for the first half of 2016, 11 percent lower than the same period a year earlier. Van Slooten says the reduction mainly related to the increased level of catastrophe losses from events such as the wildfires in Canada, hailstorms in Texas, flooding in Europe and earthquakes in Japan and Ecuador. However, he stresses these losses were below most companies’ budgeted levels.

The aggregate combined ratio for the ABA group was 94.7 percent, compared with 91.4 percent in the first half of 2015. The results again benefited from prior year reserve releases, which aided the combined ratio by 4.6 percent.

Van Slooten says that without these releases, the group’s aggregate combined ratio would be 99.3 percent. “Even with a slightly below average catastrophe load, current year underwriting is barely profitable. This shows the extent to which margins have been eroded over the past few years,” he adds.

Meanwhile, the low interest rate environment is resulting in declining investment returns.

As a result, the ABA’s net income was down 19 percent to $8.5 billion, while average return on equity (ROE) dropped to 8.8 percent, compared with 9.9 percent a year earlier.

“We are seeing a steady erosion of ROE due to all these challenges,” Van Slooten comments.

Money in the wings

Despite these challenges, total reinsurance capital increased in the first half of the year by 4 percent to $585 billion, comprising $510 billion of traditional capital (up 3 percent) and $75 billion of alternative capital (up 5 percent), compared to year-end 2015.

Most of the growth on the traditional side was driven by unrealised gains on bond portfolios. These stemmed from reductions in interest rates during the period, which were partly related to the UK’s unexpected vote in June 2016 to leave the European Union .

Alternative capital continues to enter the re/insurance industry, but at a slowing rate. Returns are lower than they used to be, but they remain attractive relative to the other opportunities available. The main draw for investors, however, continues to be low correlation with the broader capital markets.

“Money continues to move into the sector, and collateralised reinsurance structures are the main drivers of the growth,” Van Slooten says. He adds that he believes there is also a lot more money waiting in the wings ready to be deployed if rates increase in the wake of a big loss.

Overcapacity on the supply side remains, but Van Slooten believes reinsurance demand is now picking up and that the gap has narrowed over the past year. He argues that, with rates as they are, it remains a very good time to buy reinsurance.

“It is a point we are looking to make at the Monte Carlo Rendez-Vous,” he says.

He adds that many ceding companies, while having a better handle on their exposures, are also keen to reduce earnings volatility. “So they want to buy cat coverage to the extent they can afford,” he says.

Van Slooten adds that some growth is being driven by Solvency II capital relief deals, while changes in rating agency A.M. Best’s methodology may drive some additional demand going forward.

“It isn’t easy, but the challenge for all of us is to overcome the current difficulties and grow the overall size of the market,” he says.

Mike Van Slooten is the head of the International Market Analysis team at Aon Benfield. He can be contacted at:  mike.vanslooten@aonbenfield.com