European reinsurers avoid Berkshire retroactive reinsurance competition
European reinsurers are shunning retroactive reinsurance while seeking growth opportunities, leaving Berkshire Hathaway unencumbered by competition, according to research by Jefferies.
After a frantic 1 January renewal, it has become clear that growth is still high on the reinsurance agenda, but retroactive reinsurance faces little or no competition, the investment bank said in a research note.
The retroactive reinsurance market has seen six huge deals over the past eight years all underwritten by Berkshire Hathaway, the analysts noted. In an increasingly commoditised reinsurance market Jefferies considers this to be a highly unusual anomaly that European reinsurers could potentially exploit to increase their growth.
Writing $20 billion of premiums in 8 years, Berkshire Hathaway appears to price for a 3.3 percent return on assets (ROA) compared to the 2.7 percent that European reinsurers typically earn.
Like other long tail business, retroactive reinsurance typically earns a higher proportion of its profits through investments rather than underwriting, making the expected return on assets vital to the price of reinsurance cover.
The importance of the expected ROA explains the current lack of competition, according to Jefferies. While the European reinsurers consistently highlight their superior “risk knowledge” to achieve higher underwriting margins, Berkshire considers possible underwriting losses to be the “cost of float”. In essence, Global Tier 1 reinsurers are split between the European liability managers who also earn a small investment return and the US asset managers who also earn a modest underwriting profit. To a reinsurer focused on investments like Berkshire, retroactive agreements lead to large quantities of cash in the first year, an attractive feature given the bias for a large asset float to invest. On the other hand, for reinsurers focused on underwriting margin such as the European players, retroactive earnings could take decades to emerge and, in the meantime, a long-term asset must be sourced to back the liabilities.
Competition is to remain low until M&A opportunities emerge, Jefferies noted. Therefore, given that a high ROA is a necessary prerequisite for generating economic value, the analysts believe that the European reinsurers will avoid writing large-scale retroactive reinsurance deals until high ROA opportunities emerge.
In the meantime, Berkshire's biggest dilemma is how to source appropriate assets, with $116 billion of un-deployed cash attesting to the dearth of attractive opportunities, Jefferies noted.
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