Tuesday, January 12, 2016

"Reinsurance Sector No Longer Earning its Cost of Equity: Bernstein"

With a flood of capital looking for yield (or favorable tax treatment in the case of hedge fund captives) pouring into the industry, underwriting standards lowered to maintain share, and sea surface temperatures in the Nino 3.4 zone having peaked in December, conditions are setting up for some serious whacks.

From Artemis:
The reinsurance sector in 2016 has now seen pricing fall so far that it is no longer earning its cost of equity, according to analysts from Bernstein. But at the same time, the analysts believe further softening is ahead, as “Earnings are not yet painful enough.”

The January 2016 reinsurance renewals saw pricing fall faster than perhaps expected, in some lines of business, particularly specialty risks and casualty, while what was the core softener, U.S. property catastrophe reinsurance, saw rates hold up perhaps better than expected.

However the overall effect on the reinsurance sector, over the last few years of a softening market, is that the return on equity of the market has declined steeply and analysts at Bernstein led by Thomas Seidl and Josh Stirling, believe that it has now tumbled so far that earning sufficient underwriting returns to cover reinsurers cost-of-capital is at risk.

The analysts ask the question that is on many reinsurance executives lips, where is the bottom of this soft market?

In recent years, the analysts note, earnings have been “flattered” by low levels of catastrophe losses and other one-offs. That means to really assess the sector you need to look at normalised earnings and returns on equity (ROE’s), which is how reinsurers price and budget Bernstein notes.

Bernstein’s analysts estimate that the decline in average normalised return on equity of reinsurers has dropped, from Swiss Re’s sigma reported 6-7% in 2015, down to just 5% for 2016.

At an adjusted return on equity of 5% the analysts explain that “the sector is not earning its CoE (cost-of-equity) anymore.”...MORE