James Vickers, Chair of Willis Re International, has said that reinsurers must respond to the myriad challenges in the current market by going “back to basics” and focusing on combined ratios.
Speaking in an interview with Reinsurance News, Vickers discussed the findings of a recent Willis Re report, which concluded that total reinsurance industry capital declined just 3% over the first half of 2020.
The decrease was far more modest that many in the market had feared following the impact of the COVID-19 pandemic, which hit re/insurers’ investment returns hard in Q1.
“The key point is that the reinsurance market is not capital constrained,” Vickers explained. “That is critical, because if you look historically at hard markets in the past, the really hard markets have been driven by a lack of capital.”
However, the weighted average cost of capital for the reinsurance industry has seen little change over the past few years and there are concerns that the market is not earning enough to cover its costs.
Additional challenges include rising social inflation, limited prior year reserve releases, and the prospect of poor investment returns continuing indefinitely as interest rates remain low.
With so many factors offsetting the resilience of the industry’s capital position, Vicker’s feels that reinsurers must concentrate on the fundamentals of their business going forward.
“It is back to basics now,” he told Reinsurance News. “Reinsurers have got to drive their combined ratios down to the low 90s.”
Previously, re/insurers could have still achieved adequate return on equity by relying on investment income, but COVID-19 has upset this model by exposing the correlation between the asset and liability side of many firms’ balance sheets, Vickers explained.
“It means that insurers have really got to concentrate on hitting their combined ratio numbers through underwriting discipline, and also carefully managing their reinsurance in order to try to help them hit numbers that they are telling their investors, they are aiming to hit,” he said.
However, Willis Re remains confident that the industry can remain profitable despite these new market hazards, particularly as pricing momentum continues to build.
“There are green shoots and encouraging signs emerging in HY 2020,” Vickers acknowledged. “So we’re reasonably calm and pleased that the industry remains well-capitalised. The underlying performance is improving, but nobody can be complacent as the current level of performance is not where it needs to be.”
On the topic of reinsurance pricing, Willis Re does not believe that rates have reached adequate levels yet, but foresees a continuation of steady price increases into next year.
“We don’t see this as a hard market, we see this as a hardening market,” Vickers said. “A hard market is when there is a lack of capital. I think we’re moving into an environment where there will be rate increases, but on a more sustainable longer-term basis.”
“There will still be cycles, but they will be much more truncated,” he concluded. “They won’t be too excessive and they won’t drop down to the same extent that they have in the past. But, inevitably there will still be a waxing and waning of rates over time.”