AM Best: Decline of specialisation as top global players solidify their position

Established reinsurance leaders have consolidated their position during 2023 as the need to meet investor demands on return on equity makes the market environment increasingly challenging for smaller, more specialised players, according to AM Best.

Speaking at the rating agency’s Global Reinsurance Market Briefing at the Rendez-Vous in Monte Carlo, Greg Carter – who serves as managing director, analytics, EMEA and APAC – said those companies that are already well-positioned will be able to expand and deploy capital moving forward, but warned the market environment will remain challenging for start-ups.

“This is a marketplace where we don't see changes in the order of the leading players. That actually contrasts with a lot of non-financial sectors of industry, where you do see new entrants causing significant disruption and changing the shape of competitive landscapes,” he said.

“It's not something we see in the reinsurance space, and I think that's probably largely down to the fact that the business is very heavily dependent upon relationships.”

Carter added that leading players were cemented in their positions following the 1 January renewals, which were widely described across the industry as “disorderly”, with difficult negotiations around price, as well as terms and conditions.

He observed that some of the newer, smaller players “played a very aggressive game” at 1.1, particularly on price, which left some cedants somewhat disillusioned with the process.

“Whereas the feedback from brokers was that the larger, more established market leaders played a more pragmatic game, took a longer-term view, and were willing to negotiate earlier and perhaps not quite so hard,” Carter explained. “In a relationship-driven business, that is something that will augment those top players' positions in the top slots.”

The decline of specialisation

Carter continued during the briefing that specialised reinsurers are becoming increasingly rare.

He pointed to new reinsurers created during hard markets – for example, RenaissanceRe following Hurricane Andrew and Arch in the aftermath of 9/11 – as generally focusing on narrow sectors of the marketplace, only to develop into broader-ranging reinsurers over time.

“We ask ourselves the question, why is that? Partly, there are some very clear benefits of diversification – regulatory capital models and rating agency capital models effectively reward companies for diversifying in terms of lowering their capital requirements,” he said.

“It's very difficult for a specialist reinsurer to produce those returns on equity that investors demand. And if you look at pricing of those companies that are traditionally the specialists, the market tends to punish them – there's a risk premium for having that specialisation.”

A mark of reinsurers’ growing diversification is the use of alternative capital by some major players. AM Best estimates $560bn in total dedicated reinsurance capital for 2023, of which third-party capital accounts for ~$99bn.

Carter reflected on past meetings in Monte Carlo five or six years ago when discussions were centred around the “threat” of alternative capital to the traditional marketplace.

“Well, that seems to have gone away completely. Now if you look, almost all the major players are making some use of alternative capital themselves, it's just become another string in their bow in terms of how they manage their capital, how they optimise the capital efficiency.”

No capacity shortage – just more cautious allocation

Discussing whether the industry is facing a capacity shortage, Carlos Wong-Fupuy, senior director, global reinsurance ratings at AM Best, argued that while available capital is not under pressure, established global reinsurers have become much more cautious in their allocation, which pressures the deployment of capacity.

“One of the things that we want to highlight is the distinction between available and deployed capital,” he said.

This is in part derived from the nuances that distinguish the current hard market from previous cycles. Where previous hardening conditions were triggered by a major cat event, such as in 1992, 2001 and 2005, this saw new reinsurers enter the market.

“We saw this hardening of the market and influx of capital, but this was at the time when market conditions were very different,” Wong-Fupuy said.

“Since 2017 this equation has been very different. The process of price discovery has been very gradual, and only in the renewals at the beginning of this year was there some comfort around the price of a policy. At the same time, concerns about interest rates have only started to materialise in the last year.”

This market cycle has seen a slow process of reinsurers’ realignment of risk profiles, reallocation of capital, and re-underwriting and pricing as larger players shift to non-cat risks to maintain financial strength.

Cost of capital has risen materially in response to concerns over economic and social inflation, as well as central bank monetary policy.

The reinsurance industry’s weighted average cost of capital decreased from 9.44 percent in 2010 to 6.38 percent in 2019, then rising again to 9.16 percent in 2021. Although declining again in 2022, some reinsurers are struggling to generate returns above cost of capital.

AM Best cautioned that meeting the cost of capital will remain a challenge for some reinsurers, particularly those that are not as well-established.

“In general, what we see going forward is very good underwriting discipline,” said Wong-Fupuy. “What we see most likely is the companies which are already able to position the market to be able to expand and redeploy that capital, whereas for brand new start-ups the environment will still be challenging.”

No “Class of 2023/24”

And yet despite historically high rates, depleted capital buffers and primary writers’ dissatisfaction with retention levels, AM Best does not foresee a significant “Class of 2023/24” of new reinsurers anytime soon.

“What we've seen is existing players able to flex their balance sheets and able to raise capital when they need to, so we don't see that there's likely to be a significant new wave of entrants,” said Carter.

“Over the course of the last year or so we've seen lots of new business plans, we've seen lots of management teams potentially talking to us about a rating for start-up reinsurers, but we've seen very few actually come to market, and the reason for that is investor appetite seems to have changed dramatically.”

Carter continued: “That goes back to the return on equity. Is this really an attractive market? Has the industry proven it can earn a decent return on capital? Well, the numbers don't suggest that, certainly over the course of the last five years.

“With rising interest rates and economies picking up post-Covid, perhaps those investors have other other priorities, and the compelling case for investing in insurers or reinsurers driven by low interest rates and a low inflation environment perhaps just doesn't exist anymore.”