It’s all in the price…?

It is probably a truism by now that P&C (re)insurers’ portfolios of Invested Assets (comprised mainly of Fixed Income securities) have suffered from relatively meagre returns because of some ten years of post-GFC interest rate suppression by the major global central banks.

So the fact that the Federal Reserve has gradually raised its benchmark rate (and is expected to continue to do so) and that 10-year US Treasuries now yield around 3% is often considered a precursor to higher portfolio NII, which is a good thing.

However, it is not as simple as that.

As Stuart Shipperlee of ratings-advisory firm Litmus Analysis recently pointed out, for reinsurers in particular, and especially for those with significant casualty books, expected investment returns on reserves are already built into reinsurance pricing models- and the brokers and their clients know that.

Therefore, if the reinsurance market is competitive and functioning as such, a dollar of premium booked which can be invested (and which is expected to provide a higher yield) becomes more valuable, leading to more competition for that dollar.

Of course, if reinsurers were operating in a generally hardening market, one might argue that they could be less aggressive on investment return assumptions and achieve better desired pricing. Unfortunately, and to state the obvious, that is not really happening except in particular loss-affected lines (and even then not to the necessary extent). The effectiveness of CAT pricing models has also gradually improved over time, so the risks of significant under-pricing should be receding. Unfortunately, that does not of itself lead to the ability to improve underwriting margins- only a truly “hard” market like 1992/1993 can do that.

So, as reinsurers approach the important 1/1 renewal season, one is beginning to hear the now-old refrain that the industry needs higher rates on line and to maintain “discipline” in the face of a broker market that has been used for years to shaving a little off the price every year. This is coupled with a hope that, if investment returns elsewhere begin to “normalize”, perhaps peak-ILS will eventually happen, and the industry’s chronic over-capacity for available business will gradually abate. This seems more hope than likely experience in the absence of some other radical catalyst. Capital will flow to where it perceives that sound non-correlated returns may be obtained- and the ILS market is one of them.

Furthermore, and somewhat ironically, a rising rate environment is likely to drive up reinsurers’ own cost of capital, as investors seek higher returns in that sector. This may give some impetus to a firmer holding of the line on necessary rate increases, but still only creates a “zero sum outcome.”

What reinsurers really need are premium revenues that are non-commoditized and offer strong, non-correlated returns when compared with CAT lines. Some think they have found that in covering “cyber” risks. However, given the inherent difficulties in modelling and setting boundaries to both the nature and the quantum of the constantly-mutating threats, we suspect that some are likely to be suddenly and severely disabused of that expectation.

At Awbury, our focus on underwriting bespoke, value-added credit, economic and financial risks readily provides a more attractive risk/reward scenario, which has generated significant returns for our partners since inception 7 years ago- a situation which we believe is both sustainable and scalable through careful risk selection across a wide range of opportunities.

One should always look well beyond the price and simple rate on line, and instead focus on the long-term risks and value of any (re)insurance business line. That is something we do every day.

Call us.

The Awbury Team

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