A new reinsurance market norm suggests challenges will persist

In general, reinsurance premiums have been suppressed since the recession because of a lack of demand and an increase in the money being bid for risks. That’s because a slower economy means businesses have less of a need for insurance and reinsurers have less incentive to write business because of a weaker market. The financial market turmoil in the aftermath of the 2008 financial crisis also made investors more risk averse. In fact, given what happened in 2008, many reinsurers are still waiting for the economy to perk up. The yields on many types of corporate bonds and other investments, including insurance policies, are low — which means investors are more likely to demand a higher return from the industry, whether through a reinsurance premium or a financial compensation from an increased capital requirements.

Until recently, the United States and other developed countries tended to run a $100 billion annual surplus in the reinsurance market, meaning that private insurers paid out $100 billion more than they collected in claims, which further cut into reinsurers’ profits.

That now appears to be changing, with the industry only posting a $4 billion surplus this year. During a recent presentation at the Casualty Actuarial Society annual meeting, Craig Sharp, an assistant vice president in Goldman Sachs’ Property & Casualty Group, presented data that suggested reinsurers’ capacity may grow.

In response, reinsurers have been reducing their reserves and maintaining a conservative view of long-term profit. The result of this has been a slight drop in reinsurers’ claims in 2012 and more likely will be a smaller surplus for 2013. The lower surplus — along with the headwinds against revenues — is expected to pressure reinsurers’ profitability in the near term.

Reinsurers are unlikely to grow revenue in the next few years, analysts say, since there’s so much pressure on their revenues, which has led to limited pricing increases. Risk is so low that “they need to write more to expand capacity, which in the absence of any new [insurance] demand is a small boost to their revenue,” said Michael Sintros, an analyst with Jefferies & Co.

There could also be some tailwinds. Reinsurers might be reluctant to expand their portfolio if reinsurance prices are only slightly higher next year because, in some cases, reinsurers can buy more insurance than they can write themselves because, as a reinsurer, they have a policy option that allows them to purchase excess insurance without paying the reinsurance cost, which brings their net premiums higher.

To make up for their lower revenues, reinsurers are expected to expand their reach by purchasing capital markets businesses. Private-equity-owned businesses, such as cat bonds, have produced increased returns, which could help lift reinsurers’ income in the future.

But those are just a few possibilities. Other analysts say the chance of the reinsurance market expanding may just mean that the pace of growth will be a little slower.

“It looks like a bottom is forming, but I don’t think any of the numbers I’ve seen really indicates that it’s a bullish environment,” said Abhishek Deshpande, an analyst with ISI Group. “It’s probably just a matter of a couple quarters of negative underwriting results before you start to see the prices get better and the insurance industry recoup some of its losses.”

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