30 April 2014 Insurance

Influx of capital may damage Bermuda

The recent influx of third-party capital could damage Bermuda’s re/insurers by adding fuel to the fire of already increased competition.

A recent report by rating agency Standard & Poor (S&P) said that Bermudian re/insurers experience strong earnings in 2013 despite increasing competition, persistently low investment yields, and a tepid economic recovery in the US and Europe.

Despite the difficulties, Bermudian reinsurers have generated strong underwriting and operating performance, with mild catastrophe losses and favourable prior year reserve development the main contributors.

In aggregate, the 20 re/insurers surveyed had a combined ratio of 85.6 percent, an improvement from 91.5 percent in 2012, and a return on average equity of 12.9 percent, up from 11.4 percent in 2012.

The rating agency views these strong results, have supported the Bermudian reinsurers' overall risk-adjusted capitalisation, as a rating strength.

But it also warned that competition from the flood of third-party capital is only adding fuel to the fire of increasingly intense competition.

“Although this mechanism has been part of the reinsurance landscape for decades, the influx of third-party capital has increased significantly over the past couple of years," said S&P’s credit analyst Taoufik Gharib.

As much as $100 billion of alternative capital could flow into the reinsurance market during the next five years, according to reinsurance intermediary Aon Benfield.

Traditional reinsurers are already competing in an attempt to deploy their excess capital. In addition, large cedants are rationalising their reinsurance spending as their reinsurance purchasing decisions are increasingly made at the group level rather than at individual operating units.

This portfolio optimisation approach is streamlining reinsurance programs and reducing the number of reinsurers used for protection. As a result, S&P believes that competition among the Bermudian re/insurers would be fierce even without the surge in third-party capital.

Growing competition and its potential to dent re/insurers' profitability caused S&P to revise its view on the global reinsurance sector trends to negative from stable earlier this year.

The tipping point came in early January, when increasingly competitive underwriting behaviour among re/insurers was observed. S&P believes this will weaken their profitability in 2014 and 2015.

“We think that companies without a defendable competitive position, or those that are more aggressive in maintaining market share by competing on price or relaxing their underwriting discipline, are most at risk,” said Gharib.

“We could revise our assessment of those re/insurers' business risk profiles to reflect the relatively higher risk. In addition, we believe Bermudian re/insurers with diminished capital buffers, or those whose earnings capacity is persistently constrained, could face rating pressure.”

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