7 April 2014 Alternative Risk Transfer

Underwriting discipline wanes as ILS intensifies

Underwriting discipline could nosedive as levels of alternative capacity intensify, according to a report by rating agency AM Best.

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 also provided some indication of the tough road ahead.

According to the report, 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.

“It seems ironic that as underwriting opportunities have waned, the reinsurance sector has attracted additional capital to a market already saturated with it,” says the report, which also states 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.

AM Best continues: “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.”

There may be a temptation to pursue riskier and more profitable investment strategies, but as the rating agency 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”.

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.

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