With an abundance of excess capital, negligible growth in global reinsurance spend and the pricing outlook continuing to soften, one of the biggest challenges facing reinsurers is deciding how to deploy this excess capital to generate a return that meets or exceeds the expectation of investors or shareholders. In the next series of GCCI posts, we consider four options good capital stewards in the reinsurance sector are currently considering: maintaining the status quo, returning capital to shareholders, pursuing organic growth or seeking M&A opportunities. The decision is not an easy one, with the best stewards employing a strategy encompassing all four options, depending upon their judgment of the market outlook and opportunities for growth.
Maintaining the Status Quo
The first option for carriers with excess capital to consider is simply to maintain the status quo. There has often been reluctance (perceived or otherwise) among reinsurers to return excess capital to shareholders and there are a number of reasons why this strategy makes sense. Excess capital acts as a buffer against future losses, particularly relevant in today’s world of low investment returns, volatility in fixed income valuations and diminishing reserve releases.
While the catastrophe losses of 2012 and the first half of 2013 were earnings events for the sector, we only need to look back to the series of international catastrophe losses in 2010 and 2011 and the subsequent distressed acquisitions or recapitalizations of badly hit companies to observe the ramifications of overexposure to certain markets.
Following such events, (re)insurers want to be best placed to take advantage of a hardening rate environment. Maintaining an excess level of capital that can be quickly deployed is often considerably less time-consuming, less expensive and more certain than raising capital post event.
Increasing retentions and cutting reinsurance spend is another way to apply excess capital. However, given current capacity and competitive rates available in the reinsurance and retrocession markets, it is debateable whether this is time to be retaining more risk. Despite the merits of such strategies, disciplined capital stewards should be wary of holding on to excess capital for too long. Excess capital is dilutive to return on equity, and consequently dilutive to market valuation. To the extent capital cannot be used to generate a return greater than its cost in the short to medium term, the more appropriate course of action is to return it to shareholders.
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