Today is the first day of hurricane season, but it may also mark the last day of a hardening reinsurance market.
While market discipline was very impressive in January, it has started to wobble in May. A month ago, I would have said pricing would remain flat to up next January absent a completely quiet hurricane season.
Now, I expect pricing will be down in January unless we have an above average loss year. What changed? Three large reinsurers decided to pursue market share.
The Terrible Trio?
If I told you some months back, there would be three reinsurers who lost their discipline, I bet most of you would have guessed Swiss, Munich, and Hannover.
Not this time. Instead, it was Berkshire, Ren Re, and Everest! Never would have seen that coming.
As a brief recap, for those not up with reinsurance news, Berkshire expanded its cat appetite generally to peak levels including writing a $1B cover for Citizens in Florida. Ren bought Validus from AIG at a multiple above recent transactions, while Everest raised $1.5B of capital to grow, after spending prior years reducing its interest in cat.
Now, these are pretty smart companies. They’re all telling you it is better to deploy capacity now than wait to see what next year brings. You can figure out for yourself what that means or keep reading and I’ll explain.
Reinsurers Rescue Florida
While Florida still has plenty of insurance problems (especially if you are a homeowner trying to find cover), reinsurers came to the rescue as there was ample capacity for local Florida insurers.
Floridian insurers who have disclosed terms have been able to buy programs with fairly similar limits to last year and a similar level of rate increases.
Why? Well part of the reason is Berkshire deployed $2B more of capital and Everest an additional $1.5B. While not every $ of this went to Florida, certainly a very large portion did.
This seems like a very odd decision. While returns are high in Florida, if there is another big loss, many insurers will go away and will not be able to renew with you next year. Even if they survive, they will not be able to afford another rate increase.
If the global market were expected to remain hard into next year, wouldn’t one lower exposure to Florida and instead grow in diversifying zones with healthier clients???
The decision to not just grow in Florida, but put extra chips there is perplexing. It only makes sense if you think this is the peak of the market and you want to go all in.
The only other explanation I have is you are betting there will be no Florida losses and you effectively come off risk at YE and can recycle the capital at 1/1 globally. That is a really dangerous game though and more gambling than maximizing expected returns.
What Validus Tells You About Ren
M&A during a hard market is unusual. There are enough organic opportunities that it doesn’t make sense to buy something instead, especially when you have to pay a premium.
Mergers tend to come at the end of hard markets when the growth opportunity is over and it is time to rationalize capital before prices fall too far.
So Ren’s decision to buy a property they did not need tells you they think we are at the end of the hard market. Otherwise, they would have found plenty of opportunities to deploy capital organically.
Clearly, the market would have tolerated an offensive capital raise for organic growth given they haven’t done one in 20+ years. If Everest could raise $1.5B, Ren certainly could have raised more.
Also, don’t forget Ren has other capital raising options such as DaVinci which is highly accretive in a hard market. I have a hard time believing the Validus portfolio will generate better returns than what Ren could have produced by asking the DaVinci investors to put more money in.
While buying Validus doesn’t necessarily add capacity to the market (while Ren grows, AIG shrinks), Ren is telling you that they think existing Validus business has better pricing than Ren, with their superior reputation and distribution, could get in the open market.
I don’t know what to call that other than a bearish signal.
The Patience of the Europeans
So far, the big Euro reinsurers are taking this news in stride. Of course, they have only had days to digest it. What will happen once they do?
The big question for me is do they start breaking ranks at 7/1 or will they last until January?
Their discipline so far has likely been somewhat mandatory due to the drag on their investment portfolios last year. But as this pressure dissipates and competitors keep growing, I think we all know they will cave and send rates lower.
When The Wind Blows
Of course, all of this is very subject to what happens with the wind this summer. If there are no major landfalling hurricanes, price pressure will be greater. If there is another Ian or Irma, things will get even harder.
That much is obvious. The question is what happens in the middle? Let’s say we get a $20B storm and the worldwide full year cat losses are average or slightly below?
This takes me back to my original prediction. A month ago I would have said rates would still be up at 1/1 in that scenario, maybe another 10% or so.
Now? I’d say a medium season is down 10% for 1/1. If it’s a truly light year? Maybe down 15-20%. The capital raises aren’t going to end with the three we just had. The “window” is open. Bankers surely are working 25 hour days. The frenzy likely has just begun. It was fun while it lasted.