The macroeconomic environment as we enter 2011 is a challenging one for the reinsurance industry. A combination of low yields, high levels of sector capital and lower rates on-line has led to a climate of persistent low valuations and stubbornly suppressed forward earnings rates. In addition, there is no clear catalyst on the horizon. Until we see a meaningful change in one of these underlying factors, the forecast is for more of the same.
Below we examine the economic factors that have brought about the current softening market as well as the forces that could serve as catalysts for an eventual change.
Sector Excess Capital: The Primary Driver of Lower Rates
The decrease in the Guy Carpenter Global Property Catastrophe Reinsurance Rate on Line Index has been driven by a range of factors, including loss activity and buyer appetite as well as general macroeconomics. While these constitute significant dynamics, perhaps the most important pricing driver is simply the large amount of global reinsurance capital. The Guy Carpenter Global Business Intelligence team estimates dedicated reinsurance sector capital (1) to be USD19 billion (11 percent) in excess of historical levels given risks currently assumed, with a defensible range of between USD14 billion (8 percent) and USD26 billion (15 percent).
Figure 2 below shows the historical capital levels for the Guy Carpenter Global Reinsurance Composite from 1998. As is evident, the equity of the composite has grown significantly over the period. From a pricing perspective, when capital levels are above trend, reinsurance rates on line come under pressure. By contrast, rates tend to rise during low-capital years. This year, with capital levels in the sector relatively high, it should be no surprise that rate on line has moved 7.5 percent lower.
Capital growth in the reinsurance sector has been so strong over the last two years
that even significant share buybacks and dividends have not been able to negate the
increase. Figure 3 drills down into the factors of capital change since the end of 2008,
a time when the global financial crisis was nearing its peak and when capital levels
were at or near period lows. As Figure 3 shows, the most important drivers of capital
development have been strong net income and unrealized investment gains. Composite shareholders’ funds have grown from USD85.2 billion to USD114.7 billion, or
roughly 35 percent, over the period. This has been in spite of large share buybacks
and dividends totaling nearly USD12 billion and heavy first-half underwriting losses
in 2010. It is notable that in 2010 specifically, nearly all net income earned by reinsurance companies in the composite was returned to shareholders in the form of
share buybacks and dividends. Still, capital levels have grown rapidly and pricing
pressure has become more acute.
Note: 1 Dedicated reinsurance capital is different than reinsurance capacity, or the total capital of insurance carriers who write reinsurance.