Reinsurers Getting Ready to Hammer it Out Over Rate Hikes

The sector, which emerged from 2011 solidly capitalized despite one of the costliest disaster-loss years on record, is nonetheless under pressure to achieve rate increases and improve underwriting results in order to compensate for lackluster investment returns stemming from the euro-zone debt crisis.

However, rate increases that reinsurers, who offer insurance to insurance companies, recently wrangled from their customers appear to have peaked, largely because of excess supply and a competitive market. That disappointed those companies that had hoped for broad-based "hard-market" rate increases.

"Given that the events of major catastrophe years such as 2005 and 2011 have not triggered any widespread hardening [of rates], we do not anticipate that any predictable medium-term scenario would do so," ratings firm Standard & Poor's Corp. said in its "Global Reinsurance" report published this week.

For the next two to three years, "profitability will remain under pressure for many reasons, including anemic premium rate rises [and] low investment yields," it said. Economic uncertainty in the euro area, excess capital, and the diminished ability to release reserves from previous years also should hit returns, it said.

In addition, the euro-zone crisis is lowering demand for insurance protection by consumers, making it difficult for primary insurers to pass on price increases to their customers.

Hopes that Europe's planned new capital regime known as Solvency II would soon boost demand for reinsurance have been dashed for now, amid signals that the January 2014 starting date for its full implementation could be delayed by a year because of the lengthy legislative procedure in Brussels, Fitch Ratings notes.

Solvency II is the EU's planned regime of enhanced requirements for insurers regarding the management of capital, risk and reporting needs designed to ensure the sector is able to meet its financial obligations even in stress scenarios.

In the short term, losses caused by the severe U.S. drought, the U.S. hurricane season and last year's disaster losses in areas that aren't usually prone to major claims, such as New Zealand, Australia and Thailand, have reminded reinsurance buyers of the need to spread their risk further.

Substantial losses caused by U.S. hurricanes would underpin reinsurers' demands for higher rates.

On the flip side, a mild hurricane season with limited payouts on claims, and more convincing signs of a solution to the euro-zone crisis, should increase chances that reinsurers could return capital to shareholders via higher dividends or share buybacks, J.P. Morgan Cazenove analysts said in a brokerage note.

Munich Re, which has a track record for capital repatriation, is expected to pay a higher dividend for 2012 and resume share buybacks in 2013, J.P. Morgan writes. Swiss Re and Hannover Re will also likely raise their dividend, it said.

However, analysts at Morgan Stanley cut their price targets, earnings forecasts and share valuations last month on Munich Re, Swiss Re, Hannover Re and Scor SE. Analysts' earnings forecasts don't yet reflect the decline in bond yields at the short end of the yield curve, where reinsurers invest most of their money, it said.

Slowing rate increases and the recent rally in the sector's share prices also contribute to the more cautious stance, it said.

Shares in the trio have surged over the past year, outpacing gains in the broader insurance sector.

Still, Morgan Stanley said it prefers Munich Re among the reinsurers, as it "offers the most relative upside" on its share price.

"Over a five-year period, [Munich Re] has distributed most capital in absolute and relative terms to shareholders, and year-to-date has demonstrated a greater level of capital discipline at each renewal," Morgan Stanley notes.

It said Munich Re is in a good position to return €500 million ($630 million) in share buybacks next year because of a strong buildup in capital.