Where are all the new reinsurers?

It is no secret that the insurance industry has experienced a hard market for reinsurance, a process that generally occurs following a major catastrophe, most notably in this millennium after the 9/11 terrorist attacks or the trifecta of extreme weather events that struck in 2005: Hurricanes Katrina, Wilma, and Rita.

But 2023-24 has been different, as a recent special report from re/insurance market credit rating agency AM Best, “The 2023 Reinsurer Class – The Class That Never Was”, makes out. The most recent hard reinsurance market, it said, is different from what came before.

The steep pricing rises experienced by cedants in 2023 followed an accumulation of property catastrophe events have led to significant underwriting losses and resulted in earnings events for almost all reinsurers. The situation in 2023 was stoked by the persistent softening of the market between 2017 and 2021. So far, so familiar.

It was during this time, AM Best wrote, that historically low interest rates caused an abundance of capital for traditional reinsurers and insurance-linked securities. These low capital costs led to reinsurers pushing for new business, while also driving margins down to unsustainable levels. In 2022, AM Best said, a mediocre underwriting year led to a re-evaluation of underwriting positions, while interest rates climbed.

Two of AM Best’s analysts sat down with GR to talk about the report. At its forefront is the firm’s observation that despite such a market usually producing a new class of reinsurers, the present market has been devoid of new entrants in the traditional manner.

“The last big class would have been in 2005,” said Daniel Hofmeister (pictured above), associate director, AM Best. “There were a few entrants coming through in the early 2010s, but these were hedge funds offering a solution for the market being so soft, and I don’t think we view them as big players in the reinsurance market. They tend to be more niche strategies.”

He went on: “If you go back to 2005-ish it was the Arch and Validus conglomeration of companies, which evolved into something more approaching specialty. When they were formed, they were trying to fill a gap in the reinsurance market. You have to go back to the early 2000s when you had RenaissanceRe and PartnerRe. Those were probably the last big, real property catastrophe formations that we’ve seen. RenRe has stuck mostly to that strategy, while PartnerRe is still there, but has diversified a bit more into other lines.”

Hofmeister’s colleague, Carlos Wong-Fupuy (pictured, top-right), senior director for global reinsurance ratings at AM Best, said that back in the early 2000s, the sentiment in the market was markedly different, as the new companies formed were aiming to take advantage, almost solely, of property catastrophe rates, specialising in this area.

The situation is different in 2024, he said.

“Right now, it’s not just that we are not seeing new company formation, but the business plans that are coming out are not particularly focused on property catastrophe. They’re much more diversified as business models. That’s what we’re seeing with the current companies in the market.”

Arguably, property catastrophe rates peaked last year to comparable highs with previous turns. So why the diversification; and why not continue in the same pure-play prop cat vein?

“There’s a couple of reasons for this,” said Hofmeister. “The big one that sticks out is that the only avenue used to be traditional reinsurance. But right now, there’s insurance linked securities (ILS) capital, so if you’re an investor, you can choose to fund a startup, over three-to-five years timeframe. There’s a quick liquidation preference. You can get into a catastrophe bond and capitalise on these rates, and be out in several months, while getting all of your capital back. It makes sense from their perspective to question why you would take on that liquidity risk.”

Another reason, said Hofmeister, is that the other lines of business are probably being driven by multiples. Even the outstanding property operators out there, he said, have seen their book value decline from historical highs, from perhaps four time, down to below half of that.

Hofmeister said that there are better book values on display in the excess and surplus lines insurance (E&S) sector, in comparison, which is faring much better from the viewpoint of multiples.

“It’s the same with the managing general agents (MGAs),” he said. “They’re trading so much better and capital is so much more effectively managed from a private equity perspective. I think that if private equity is going to lock in their capital for a time period, they’re going to go for something with a higher multiple.”

He went on: “Investors don’t really see franchise value in the property catastrophe market. The ILS market has been helpful for the reinsurance industry, it’s led to much more stability in that sector, but I think it will restrict new capital from coming in, because where’s the benefit to investors by dumping in new capital to a market probably not going to remain hard for five years. There’s at least a few years of softening market, so it’s hard to imagine capital coming in for property cat, specifically.”

AM Best’s report makes clear that there is a lack of interest from venture capital in moving into this space. Private equity and other investors, it said, are not appearing to show any interest in supporting start-up non-life reinsurers. It is a situation that Hofmeister acknowledges, saying that AM Best hears that there is passive capital out there – sovereign wealth and pension funds – but they would generally need a private equity type partner to also be present to manage the finances, and it is the latter that is opting to leave their capital at home.

“They are more focused on three or five year liquidities. They don’t want to partner so that their capital gets tied up. They’re really the bottleneck in the whole chain,” Hofmeister said.

While this looks stark for the future of the industry, he notes that ILS markets, too, are very capable of being burned by poor performance, as has happened in the past, while the ILS market’s continued lack of penetration into casualty risks is also limiting its ambitions.

Another and more long-term issue in the industry is that of climate change, which Wong-Fupuy said is changing the very nature of the industry, in terms of its effects on property cat business.

“It’s not just about the cycle,” Wong-Fupuy said. “There are a couple of long-term trends, one of which is our changing climate that’s impacting the frequency and severity of natural catastrophe losses. That’s something that goes beyond cycles. There’s an ongoing reassessment of that and how it can be properly priced, underwritten, and brought into balance sheets. That’s another reason why we think companies are looking at this diversified business model.”

The second point, he said, is the effect of interest rates on the reinsurance market.

“We cannot look at the reinsurance market in isolation,” Wong-Fupuy said. “Investors are looking at this compared to other alternatives. We had a long period of time with very low interest rates and investors looking for diversification, and reinsurance looked attractive. Right now, rates are much higher, and although 2023 was a stellar year, reinsurance is a segment which, for several years, has underperformed.

Investors are not impressed by a single year with a high return on equity (ROE).

“Sure, reinsurers got 20% return-on-equity in 2023, but in 2022 it was almost zero,” Wong-Fupuy added.