Coping with excess capacity in the (re)insurance market
Over-capacity has become a new norm in reinsurance. With enhanced pricing techniques and stronger regulations, pricing is becoming more accurate,...
...volatility is reducing and the cyclical price movement tending to be smoother than it has been historically.
Certain events may cause a significant outflow of alternative capital, such as multiple large catastrophe (CAT) losses, substantial asset price distortion or regulatory change. However, the uncertainty of these ‘trigger’ events means that (re)insurers are mainly taking a reactive approach to possible market changes that harden the market.
By better understanding the supply-demand dynamics of capacity, (re)insurers can better predict rate changes and make more informed decisions on the entry/exit of product lines. In a typical cycle, excess capacity initially flows to established products with attractive, risk-adjusted returns. As supply continues to increase, the return gap is narrowed and finally eliminated, with capital shifting to new areas. That said, product lines with increased demand typically offer a higher margin and continue to attract new capital throughout the cycle. This is evidenced by the recent stabilization of capital supply in property lines, and an increasing market interest in specialty lines like cyber and political risk.
Facing the threats of alternative capital and downward pricing pressure across lines, (re)insurers can either adopt a defensive strategy to optimize operations and cut costs; or pursue an attacking strategy to innovate and grow in emerging risk areas. Moreover, a collaborative strategy to partner with alternative capital providers would allow (re)insurers access to low-cost capacity. By utilizing the excess capacity efficiently through insurance-linked security (ILS) structures, (re)insurers could expand their businesses and drive future growth.