As investment and underwriting opportunities wane, the global reinsurance sector has attracted new capital to a market already abundant with it. Managing Senior Financial Analyst Greg Reisner and Financial Analyst Scott Mangan spoke about this new wave of capital, and said while it may be changing the game for traditional reinsurers, the same headwinds still apply. In addition, Senior Financial Analyst Gale Guerra spoke about the reinsurance industry's return on equity. The following is a portion of the transcript of the May 2013 episode of First Monday, which also features Senior Associate Editor John Weber.
Reisner: Quite frankly, the challenges aren't new ones. We've been harping on these for quite some time and they're not a secret to anybody. The first challenge is the low investment yield environment. The second challenge is the unsustainable loss-reserve development: while it's favorable right now, that's not going to be there forever and I think everyone knows that. The third challenge is the less-than-robust pricing power.
On the pricing side of the equation, while it's improving, what's keeping a lid on stronger improvements is the abundant capacity. When we think of capacity, it's organic in terms of companies are growing nicely, but on the other hand, you have third-party capital coming into a market that's already saturated with it. The challenges are being managed two-fold: one is cycle management. Over the past several years, companies have been migrating away from longer tail casualty lines of business, toward shorter tail property-oriented lines of business. The second is capital management.
Mangan: The most frequently used capital management tool has been share repurchases. Since 2008, the companies that make up the global reinsurance composite have purchased over $25 billion worth of shares. In 2013, barring any major catastrophes, we expect reinsurers to purchase between 50% and 75% of net income.
Reisner: It's not just about capital management in terms of your own enterprise capital. It's also about matching third-party capital now. A lot of companies are looking into managing third-party capital, to get that practice, if you will, to demonstrate they can manage third-party capital. The view is that third-party capital, while it may or may not be here for the long term, it's here for now. And that here and now could be still a few years. If that capital leaves, companies have to think about how they're going to manage that reputational risk as well.
Weber: That said, a composite analysis of the sector for 2012 revealed reasonably good news.
Guerra: They returned to profitability and were also seeing an improvement in their overall earnings. The composite produced a combined ratio of 92, which is a significant improvement over the 107 in 2011. The return on equity for the reinsurance sector is at 12% for 2012, which is remarkable when you consider all the challenges that companies are currently facing. Although we are not anticipating that the ROE will continue in the double digits, we are anticipating that with the investment environment and the earnings weakening, in the future it will only be the high single digits. The reinsurance segment was able to also increase shareholders equity. From 2010 to 2011 it was relatively flat, but they bumped it up a bit in 2012, which is good for the sector.
It's going to be very important for the global reinsurance sector to focus on underwriting because they will not have the crutch of the investment earnings that they currently enjoy as investment yields continue to decline.
Mangan: A.M. Best is maintaining a stable outlook in the global reinsurance market. The outlook is supported by strong risk-adjusted capitalization and prudent use of enterprise risk management in a somewhat stable pricing environment. However, we do caution that with increased capacity, pricing could erode. With investment yields already being squeezed and an anticipated decline in favorable reserve development, underwriting discipline remains the key to the ongoing stability of the global reinsurance market.